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Tales of the Great Indian Rupee

If the rupee had a face it would resemble Buddha with a smile says Noshir Paisawalla.

There is so much to the Rupee that is shunned in preference to the Greenbill. One popular perception is that the more we have of these bills the better we are in tiding over our consumption demand.

The Indian Rupee has traditionally been perceived as a weak currency. Such a negative perception is not without reason. India's high cost-structure economy meant that the currency periodically lost its purchasing power. Indeed, in the late Eighties and the early Nineties, the Wholesale Price Index (WPI) inflation averaged a whopping 10 per cent year on year, exacting a severe toll on the balance of payments position and eventually the currency.

However, the market reform programme that followed first under the auspices of the Congress government and then other coalition rulers, injected competitive and allocative efficiency into the Indian economy. Coupled with the Reserve Bank of India's (RBI) adept monetary management this has improved inflation performance dramatically. The pace of WPI rise has moderated to a mere 5 per cent year on year in the latter half of the Nineties (and remarkably under 1% this calendar year), helping weed out some of the bearishness of the INR. Further the deteriorating foreign exchange reserve scenario also added to the weakness of the Rupee. Though by and large the Rupee remains determined by the Reserve Bank, the market sentiment does reflect in which way the Rupee would move.

Now that a benign inflation environment has been established, the big question is whether it can be sustained. There is reason why it cannot be given the rise in the oil prices. However, the downtrend in inflation seems to be ending. Once the formation of the new government is done, it is inevitable for them to adjust the oil prices which would obviously hit the basic cost and pushing the prices higher.

As India's economy stages a cyclical turnaround over the next two years (commensurate with the global economy), it will provide authorities with the much-needed springboard for further reforms, especially those embracing the public sector. If realised, the ensuing productivity gains will help detract from the inflationary effects of the higher growth trajectory. By doing so, they will continue to route the flow of investment dollars into the Indian economy - lowering the risk premiums demanded on Indian Rupee.

What will also contribute to a similar Indian Rupee outcome is a new international financial market architecture that appears to be evolving since last autumn. Following the worst ever global currency crisis in 50 years during 1997-98, major central banks now appear to be acting in unison to check currency volatility.

The preception of the global investors towards Indian markets has changed, showing confidence in the reform process. This would definetly be a boost to the foreign exchange reserves giving the required cushion to the central bank to curtail any speculative attack on the rupee. This will further lower volatility for the dollar ruppee rate, mitigating as it does the need for adjustment of the trade-weighted exchange rate.

As it is, the Reserve Bank remains the major factor and whatever depreciation in the Rupee so far has happened, it is well within the preview of the central bank. For instance, when the Rupee slipped from 42.80 to 43.30 levels during the Kargil crisis, one of the Reserve Bank Governors stated that the RBI would not create conditions wherein the Rupee will be back in the sub 43 levels.

If you look at the forwards, on the other hand, they have been showing steady movement- shuttling between 5-6 per cent after having witnessed 25 per cent rise in the previous years. Though the Indian market does not show a major correlation with the money marekts, off late this trend is picking up which has been taking the heat from the forwards.

In view of India's steadily improving medium-term structural and cyclical fundamentals, traditional theories pricing in a 7 to 8 per cent Indian rupee depreciation annually appear excessively pessimistic.

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