Subir Roy: Spikes will come and go

VALUE FOR MONEY

When the rupee touches a nine-year high against the US dollar, an explanation becomes necessary. Does it reflect a secular improvement in the competitiveness of the Indian economy vis-à-vis the US, its most important trading partner? Or, have perceptions about the US economy moved down vis-à-vis other economies, particularly important ones in Asia? Or are the current fluctuations in the value of the rupee purely a reflection of short-term changes like the central bank going easy on mopping up dollars (to stop creating money)? Or have Indian companies decided to bring home in a bunch the funds they had raised abroad and were till now holding there?

The first point to note is that over the past 12 months or so, most important Asian currencies have moved up against the US dollar and the rupee has moved in tandem with them. The rupee's rate against these other Asian currencies has been quite steady. The major exception has been the Japanese yen, which has depreciated against the US dollar largely because Japanese interest rates are so low that it pays to sell yen, buy dollars and invest them in dollar-denominated securities.

From this follows a major lesson for the Reserve Bank of India. For whatever good reasons you may have, don't jack up Indian interest rates, increasing the differential between them and those of India's important trading partners, when expectations are running high over the immediate future of the Indian economy. If you goofed and then stopped buying dollars so as not to add any more to the money supply, then of course the rupee will zoom. The interest rate weapon is simply not available at this juncture to tackle inflation. We know life is tough but try some other medicine. 

FOREIGN INFLOW (in billion US dollars)
	02-03	03-04	04-05	05-06	06-07*
NRI	28.52	33.26	32.97	35.13	39.13
FDI	5.03	4.32	6.05	7.72	16.44
FII	0.37	10.91	8.68	9.92	3.50
* Till January

But there is no reason for the RBI to worry overmuch. Despite the rupee being sky-high, the forward market for the dollar is quite liquid (there are lots of buyers and sellers) and, wonder of wonders, the forward dollar is still quoting at a premium vis-à-vis the spot dollar. This means there are loads of importers with major import schedules who like to sleep peacefully and so are booking forward dollars (crystalising what their import bills will be). Correspondingly, this is a boon for the likes of TCS and Infosys, which are getting a nice price for their export dollars, whose rupee equivalents they like to crystallise up to a point.

Everybody please thank the finance ministry for lowering import duties and increasing the import appetite of the economy, which does a lot of good to prices and Indian competitiveness. The appreciating rupee makes life difficult for the commerce minister but may he stew in his own juice. May exporters who have been hooked on incentives and a rupee kept artificially low suffer likewise. There is no need to worry. Export sectors with intrinsic competitiveness like software and other knowledge-based services, auto components and refineries (textiles may please get its act together a little more) will come in to fill the trade gap.

To be sure that the present rise in the rupee is a bit of a spike, we need to reassure ourselves that there is no sudden surge of hot money. There is good news on both the foreign direct investment (FDI) and foreign institutional investment (FII) fronts. FDI (the money that stays) is booming, running at over twice last year's rates with two more months to go (April-Jan). Additionally, FII inflow is down to a third of last year's level for the same period. However, NRI deposits, perhaps the most fickle among capital flows, are running well above last year's levels. But this is not happening because India is paying exorbitant interest rates. Quite the contrary. The ceiling for dollar-denominated deposits, more than which Indian banks cannot pay, is 25 basis points below LIBOR, the rate that prime global banks pay for deposits. For rupee-denominated deposits they are 50 basis points above LIBOR.

To turn our eyes to the fundamentals, what is really happening in the Indian economy? The corporate sector is booming and earnings have been doing exceptionally well quarter after quarter, without any sign of letup. The macro economy is stable, and inflation, having gone up worryingly, is now apparently coming down again. Agriculture is still seriously ill but at least the rains have been good and the rabi crop is likely to be bountiful. There is every reason for global investors seeking long-term gains wanting to invest in India and hence the rise in FDI.

However, stock market valuations appear to be high and hence the letup in FII inflow, which can be volatile. If the Indian stock markets have held up (albeit with a lot of volatility) despite the fall in FII inflow, then that speaks well of the domestic investor base. Thus, overall, the Indian economy continues to do quite well. There has been no major exchange rate appreciation. In an increasingly open economy, the exchange rate cannot for long be misaligned against the inherent competitiveness of the economy. Spikes come and go.

sub@business-standard.com