A rising rupee

The sudden rise of the rupee against the dollar, after several weeks of inactivity, has led to speculation about the reasons for the Reserve Bank of India's (RBI's) decision to let the currency appreciate.

Despite its protestations, the central bank has for long actively managed the pace of appreciation, preferring to let the rupee float up gently rather than let the market dictate the rise.

The $110 billion worth of foreign exchange reserves are compelling evidence of that policy. The Reserve Bank's decision to let the rupee rise last week is accordingly not business as usual.

To be sure, the central bank governor has been at pains to emphasise that concerns about inflation are not behind the RBI's non-intervention.

Nevertheless, it is also true that the central bank has substantially depleted its stock of government securities in its effort to sterilise inflows, and till it gets new ammunition in the form of market stabilisation bonds and fresh government borrowing in the new fiscal year, it will not be in a position to sterilise the effects of dollar buying. That would result in increased money supply, with possible inflationary consequences at a later date.

Far better, in the circumstances, to let the rupee go up, at least for the time being. And while the central bank has insisted that all it is doing is managing volatility, it is also a fact that central banks across Asia, from Japan to Korea and Malaysia, are re-assessing their policy of holding down their currencies against the dollar.

That re-look is being prompted by the effect of rising commodity prices on inflation, on the one hand, and of the costs of piling up foreign exchange reserves on the other.

With India's foreign exchange reserves at $110 billion, the costs of intervention are going up, and it can be nobody's case that the economy needs such a high level of reserves as protection against trade shocks. As a matter of fact, India weathered the Asian crisis and the nuclear tests with far lower levels of reserves.

That leaves only one policy excuse for keeping the value of the rupee down"" helping exporters. But with the latest data showing robust export growth, it's hard to argue that exports are suffering because of the rising rupee.

True, exporters' margins will be affected, but that can be made up by rising volumes, or, more importantly, by increasing productivity.

Export growth is more a function of increased demand rather than a low exchange rate, and this is brought out amply by the fact that exports grew 1.7 per cent in FY 2001, when the rupee depreciated by 7.07 per cent, while growth has been in the double digits this fiscal and in FY 2003, despite the appreciation of the rupee.

It is the structural change in Indian services and manufacturing that is driving exports, rather than a cheap currency.

In any case, the continuing attraction of India as a destination for FII flows, coupled with inflows of external commercial borrowings, should continue to put upward pressure on the rupee.

For exporters, the message is a simple one "" they must continue to increase productivity to remain competitive, as they have done so successfully in the last couple of years.