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August 2, 2000
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Rupee on threshold of a disastrous fall?

Our Forex Analyst in Bombay

The rupee continued to fall steeply for the third trading day in a row this Wednesday morning, falling to a new low of 45.37, before closing at 45.35, against the US dollar. The dollar demand, which remained unabated and the dearth of inflow of dollars are exerting the pressure on the rupee. The indifference of the central bank to the current decline would be assumed by the market that it is comfortable with the rupee's current level.

In fact, on Tuesday evening speaking to reporters after a meeting with the Finance Minister, RBI Governor Bimal Jalan said that was not worried about the recent fall in the rupee's value and that the central bank was not planning any immediate policy measures to defend the currency.

This message comes in harmony with an earlier statement by the Union Minister of State for Finance, Dhananjay Kumar, in Parliament last week. When asked about the rupee's recent fall versus the dollar, he explained that the fall had adjusted for an appreciation in real exchange rate terms and would help India's exports. He said it will also offset some of the competitive disadvantages arising from the sharp depreciation of currencies of India's competitors in South Asia and neighbouring countries. Besides, it is also expected to restrain imports.

Together with the recent official stance, the rupee's historic fall with negligible recovery prompts unanimous dollar-buying against the local currency. The rupee had remained in a broad range of 43.40 to 43.70, almost for a year before it started its recent slide in May. The authorities must have given the initial impetus for the rupee's real value adjustment, but the economic factors took over thereafter.

The heavily indebted government's debt-servicing obligations in respect of foreign currency loans, as also huge oil, defence and other import bills of public sector undertakings must have got or allowed to be bunched in a short period.

The situation must have been unexpectedly aggravated by the foreign institutional investors' repatriation of funds after booking profits in equity investments. This was a double blow as it slowed the inflow tap and aggravated the dollar demand.

After being net buyers of equities to the tune of $581.7 million and $67.1 million in April and May 2000, they turned net sellers in June and July amounting to $230.7 million and $315 million, respectively. Meanwhile, the drama around Shiv Sena leader Bal Thackeray's arrest and subsequent release added variety to the reasons for rupee's fall.

The central bank took certain measures recently to control the pace of depreciation: on May 25, it imposed 50 per cent surcharge on lending rates on import finance and 25 per cent interest per annum on overdue export bills, made arrangements to meet Indian Oil Corporation's dollar requirements and gave access to FIIs to approach them for repatriation of funds. The impact of the measures was felt immediately as the rupee recovered from 44.75 to 44.10 on that day.

In the subsequent weeks, the rupee continued to be haunted by the unending dollar-demand and continued to fall progressively.

When the rupee breached the level of 45 on July 21, the central bank tried to break its fall and imposed these monetary measures: it raised the Bank Rate by one percentage point to 8 per cent, CRR by 50 basis point in tranches of 25 basis points each beginning 29 July and 12 August and also cut refinance limits by 50 per cent. Apparently these measures have failed to have the necessary impact on the pace of depreciation of the exchange rate due to failure thereof to absorb the excess liquidity in the system.

The government reported that the trade deficit rose by 26 per cent for the period from April-June 2000 to $2.98 billion from $2.37 billion compared to the corresponding quarter last year, despite a 27.65 per cent jump in exports for the same period. Exports jumped about 28 per cent to $10.19 billion for April-June 2000. During the same period, oil imports surged by 94.26 per cent to $3.94 billion from $2.03 billion.

While the rupee depreciation is unlikely to reduce the oil import bill in foreign currency terms, it may certainly lead to cost-push inflation and better margins for the local business.

The rupee's future direction rests solely and squarely on the shoulders of its guardian angels: namely, the RBI and the Ministry of Finance.

(Disclaimer: Views expressed in the analysis are those of the analyst, not necessarily those of


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