Rupee may cross 42 to the dollar

(D. H. Pai Panandiker is President of RPG Foundation. The views expressed in this column are his own)

By D. H. Pai Panandiker

The rupee has been on the climb after it bottomed out in March last year at 51 to the dollar. The earlier fall was due to the exit of FIIs after the financial crisis and the present rise is largely due to their return.

How far they will push the rupee up depends on the size of the inflow and the willingness of the RBI to intervene in the market.

The climb since March last year has been sharp. That climb took place in two steps. In April-May last year when the FIIs started to return the rupee jumped 5 per cent. That was followed by a long pause. The second jump came after the budget when the rupee crossed 46 to the dollar.

Apparently the RBI is not worried about the appreciation of the rupee. Almost since May last year it has not intervened and has left the rupee-dollar exchange rate to be decided entirely by the market.

One reason may be that the rupee before the financial crisis was trading at less than 40 to the dollar which may be taken as the normal rate. As such there is a lot of room for the dollar to crawl up. The other is that the RBI is concerned about excess liquidity in the banking system and would not like to increase it further by buying dollars.

But the rise of the rupee has made exporters uneasy. Indian goods will be 12 per cent more expensive to the Americans. But not Chinese goods. That is because China has tied the yuan to the dollar in spite of ‘pursuation’ by the US to expose the yuan to the market. It is unlikely that China will take any early revision. That blunts India’s competitive edge.

It is not the US market alone where Indian exporters face exchange handicap. The euro has weakened against the dollar and Indian goods and services have become 22 per cent costlier to the Europeans. Yen is the only major currency which has appreciated against the dollar.

The climb of the rupee after the budget is an indication that it will climb even more in future. That is because the inflow of dollars will increase with the FIIs investing in Indian stock and bonds. The Indian stock market is in a bull phase and FII investment is expected to increase to about twice the highest amount received in any year so far.

There is also bound to be a significant expansion in foreign direct investment which, even during the recession time, did not decline.

But, with the hardening of the rupee the trade deficit will inflate because imports will rise much faster than imports.

The additional deficit is, however, likely to be more than made up from export of services.

Every signal indicates that the rupee will harden in the rest of 2010. Quite likely it will cross 42 to the dollar if the RBI does not intervene.

(You can e-mail Dinker H. Pai Panandiker at: dpanandiker@gmail.com)