[caption id="attachment_361" align="alignleft" width="120"] Ashutosh Kumar
Dy Director, CCI, New Delhi

The Indian rupee has been falling in value quite consistently over the last two years. However, since early May 2013, there has been a significant fall in its value leading to a historic low at Rs 68.85 per dollar by the end of August 2013. The weakness of the rupee since last two year is a result of a deterioration of India's economic performance, especially the deterioration of its balance of payments. Such weakening in an economy that through liberalization has made itself dependent on foreign financial only leads to heightened instability. As we know the main reason of this crisis or depreciation of rupee is flight of foreign capital. Flight or inflow of foreign currency depends on: (a) the expected depreciation of the domestic currency; (b) backup in the economy to fight with capital flight (measured by the amount of foreign reserves the domestic economy holds); (c) how non-interventionist the government is (d) how investor-friendly its capital account is. Here all these factors are against India. Hence sufficient amount of foreign capital is not coming to India.

There are some other reasons for this crisis as well viz.,

First, since US and some European economies are also facing crisis, the demand of Indian goods from these countries has decreased. It means Indian export has been decreasing. Second, the import by India is increasing in terms of monetary value. Significant part of it is either unnecessary or luxury goods which is unproductive. Third, no coordination between RBI and Government which means Government and RBI is not working together to tackle the crisis.

The rupee has been gaining ground, measured against the dollar, valued at 59.03 to the dollar (as per RBI's reference rate) on May 31, as compared with 60.2 at the beginning of the month and 62.7 at the end of the January. This appreciation, however, needs to be put in perspective. When compared to a year back the rupee on May 31, 2014 had appreciated by about 8.6 per cent vis-a-vis the dollar.

This appreciation of rupee is definitely an achievement but before celebrating this achievement we should examine that whether it will continue in long run.

First, though current account deficit of India's balance of payments has come down quite significantly which is largely a result of a fall in gold imports, India remains a deficit country. It means India expending more foreign exchange on its current account transactions than the foreign exchange it earns. So if currency movements are influenced by the net value of current transactions, the rupee should be depreciating rather than appreciation. This is the long-term tendency in the external sector.

So, Second, it implies that the factors explaining the rupees fluctuations are largely related to the capital account. The net inflow of capital (or its expectations) creating pressures for the currency to appreciate. Thus the recent (relative) appreciation is the result of a capital surge, whereas the July-August 2013 depreciation was because of fears that the US Federal Reserve's decision to taper out its easy money policy would result in capital flight.

Third, the recent net inflow surge was largely the result of large speculative FII inflows into equity and debt markets. Speculation that a stable, assertive and business-friendly government elected to power, shoring up profits and profitability, encouraged large inflows. Net inflows over the year ending May 15, 2014 amounted to $5.98 billion, whereas that during the four and a half months since the beginning of this calendar year amounted to $11.73 billion and during the first 15 days of May as much as $2.24 billion. This has not merely generated a bubble in the stock market, with the Sensex soaring to record highs, but triggered a short-run appreciation of the rupee, because of excess supply of foreign exchange.

The problem is that when the rupee is appreciating, the dollar returns that short-run foreign investors earn in the equity market tend to rise. It stimulates capital inflow in speculation market which is very volatile in nature and always keeps flying wherever the profitability is high. If this appreciation would have happened through current account surplus, we may infer its stability or further appreciation. To conclude, given this character of the forces driving rupee appreciation, it is unlikely that the surge would continue and the likely possibility is that it may even be reversed, encouraging capital exit.