Rising rupee poses another headache for RBI Governor Raghuram Rajan

 Anand Adhikari        Last Updated: May 26, 2014  | 21:00 IST
Rising Rupee poses another headache for RBI Governor
(Photo: Reuters)

Anand Adhikari
If the depreciating rupee sparked near panic in 2013, the currently appreciating one will also create problems for Reserve Bank of India (RBI) Governor Raghuram Rajan.

The rupee has already appreciated from 69-levels in August last year to 59 against the US dollar. This was partly because of the measures taken by Rajan to bring in dollars through the foreign currency deposits window and the sudden inflow of dollars into the country's equities and debt market.  

Foreign institutional investors have been net buyers of equities and debt to the tune of $10 billion in the first four months of 2014. The figure was exactly the same for the entire calendar year 2013. "Another $20 billion in next eight months will strengthen the rupee further," say dealers.  

The rupee had earlier appreciated to 39-levels against the US dollar in the period up to December 2007 when the country saw high growth as well as a soaring capital market. But the domestic currency started weakening post 2008 in the aftermath of the global financial meltdown.

The period saw the RBI running from pillar to post to stabilize the rupee's value by introducing measures such as higher import duties on gold, restricting of overseas spending limit of individuals and disallowing rebooking of cancelled forward contracts.

But now with a possible stable government at the Centre, there is likely to be a new problem at hand. "The stability at the Centre will create a conducive environment for foreign investments both FDI as well as FII in India," says a dealer at the PSU bank.

Kishore Narne, who heads currency at domestic brokerage firm Motilal Oswal says the RBI will be comfortable with the rupee appreciating against the US dollar in the short to medium term. "An appreciating currency will help the RBI in its battle against inflation. The strengthening currency will make the oil and other imports cheaper," says Narne.

But some question the wisdom of the RBI trying to fight inflation through an appreciating currency. "The appreciating currency will impact country's export competitiveness," says a dealer. 

Experts say any emerging economy like India needs capital inflows to bridge its current account deficits and also maintain a health foreign exchange reserves, but if they attract more inflows than they can absorb, it impacts the economy severely.

First, it will make our exports uncompetitive in the international markets. China for long has artificially depreciated its currency because despite getting huge dollar inflow, the mainland never allowed its currency to appreciate above 6 .20 levels against the US dollar.

The rising capital inflows also build up asset bubbles in areas like real estate, housing, stock market etc. The huge inflows create a sudden demand for assets whereas supply takes times to match. This is something we saw in the period of 2003 to 2008 when stock soared from a level of 5000 points to 22, 000. Later, what followed is the history.

Thirdly, a rising capital inflows fuels inflationary pressure . This happens because RBI has to convert (or pay) for every dollar that comes into India into rupee resources. The money supply increases as inflows rise. So higher the money supply, the chances of inflation getting further fillip is not ruled out.

And lastly, the interest rates. Higher inflation means higher interest rates. The RBI will be back to fire fighting inflation under the new government possibly under Modi.

That's not enough. What is more worrisome is their sudden reversal. Since they are hot inflows,the money also goes away as fast it comes.

K Harihar, treasurer at First and Bank, a foreign bank in India, however, says the rupee (appreciation) hasn't come to that stage yet. "If the GDP picks up, the import bill will also move up because of capital goods and oil," says Harihar. There are also murmur of overheating in the stock market, which will result in pulling out of foreign money out of India.  

Rajan surely has a tough task going ahead whichever way the rupee heads against the US greenback.

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