Rupee crossing 80 to the dollar is nothing to be startled about

While the impact on other currencies has been sharp with most of them depreciating, the rupee has done well, being somewhere in the middle

Rupee at 80 means that another psychological barrier has been crossed and we can now look forward to 81 or 82 as markets keep guessing the future trajectory. Should we be worried? Probably yes, because any depreciation of this intensity is a matter of concern. However, we may have to bear some judgment here.

One factor that has been driving currencies is a strong dollar. The dollar is strong because the Fed has been proactive in raising interest rates with the economy overheating due to the unemployment rate dipping below 4 per cent. As a result, the Fed has been the first to trigger rate hikes to bring down inflation. This makes the dollar stronger as investment flows turn back and move to local shores. The impact on other currencies has been sharp with most of them depreciating. In this context the rupee has done well, being somewhere in the middle. Therefore there is nothing to be startled about.

In fact, if the Reserve Bank of India (RBI) had forced the rupee to stay at a lower level of 77-78, it would have meant that we would lose our export competitive advantage as other currencies would have gained. Therefore a balanced view has been taken to ensure that the rupee falls, but does not tumble. This is rather cogent forex management.

But can we sit back and relax? The answer is probably no because a weaker rupee also goes along with weaker fundamentals which are affecting our balance of payments. The trade deficit is widening as recovery in India means higher non-oil imports along with higher oil imports. Exports may not grow at the same rate as the central bank's actions will lead to higher interest rates and global growth will slow down. Therefore a wider trade balance means a higher current account deficit. It can be above 3 per cent of GDP this year which is high though not scary.

The RBI has quite rightly invoked measures to get in more capital flows. The recent measures to widen the limits for ECBs as well as letting banks offer higher rates on NRI deposits are measures that should get in more dollars. However, it depends on the responses of the players in the market. With interest rates rising in the US, NRIs may not choose to put money in Indian banks. Similarly, higher rates in the West may not be attractive for ECBs and therefore despite the RBI opening the door fairly wide, there may not be a crowd waiting to get in.

All this means that along with inflation the external account will require constant monitoring and action by the RBI. A weaker currency also has implications for inflation though assuredly the declining trend in commodity prices will provide a buffer against imported inflation. The global scenario also needs to be considered as the runaway strengthening of the dollar cannot be unlimited. The ECB has also spoken of increasing rates, which can counter this movement in the dollar. Moreover, the Fed action should bring in some slowing down of the US economy. The other factor which will continue to dominate the landscape will be the investment flows that will diminish as the QE part of the story comes to an end. There are talks that there could be a re-run of this exercise in the future, but one cannot be sure.

Madan Sabnavis is the chief economist at Bank of Baroda and author of: Lockdown or economic destruction. Views are personal