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High inflation, dipping foreign fund inflows maul rupee

Syed Firdaus Ashraf in Bombay

Gautam Ashra, a forex dealer and partner at Kanji Pitamber, usually walks in a relax mood to his office at the crowded Fort area of Bombay.

But this morning his mood was tense, he knew some thing major was going to happen in the forex market as the rupee had been losing ground against the dollar since the last three days.

His nightmare came true at 11.00 AM, when the onslaught against rupee began early in the trading hours.

The Indian currency started falling seemingly into an abyss. At 11 am, it was at 44.21 against dollar, at 1.30 pm, it had held its ground at 44.23. But 3.00 pm it had plunged to 44.60. But the slide would not stop. By around 4 pm, it reached seemingly irrevocable depths of 44.78.

Panic gripped the markets. Corporate demand for dollars was heavy, the state-run banks were apparently doing nothing to halt the rupee's free-fall.

It was then that the Reserve Bank of India, or RBI, came to rescue the rupee. The RBI's intervention brought about a drastic change in the direction the rupee was taking. The Indian currency first stabilised and then actually firmed up significantly to finally close at 44.29 to the US greenback. However, 44.29/$ was still the all-time low closing level for the Indian currency.

However, says Ashar, "The RBI is not doing the right thing by intervening, as nobody knows what is the real value of rupee. This is really not good for Indian rupee in the long run."

Apparently, the experts believed that the rupee will stabilise at Rs 44.25 for a longer period, considering that inflation is at a 73-week high. But, the market proved them wrong as the rupee touched Rs 44.78 in the intra-day trading and closed at 44.29 after the RBI intervened.

"Inflation has been rising for quite some time now and this really affects the rupee. Also, interest rates in the United States have been hiked and many foreign institutional investors, or FIIs, feel that it is much better to keep their money in the US as the move will fetch them better returns. Thus, they are moving out of the Indian markets," says S S Bhandare, economic advisor, Tata Services.

Compounding the problem was the crash of the ICE (Infotech, communication and entertainment) sector stocks, which dragged down the bourses. The investors' expectations too are very low at the moment. The BSE Sensex touched an all time high of 6,000 points and dropped below 4,000 points in just a couple of months.

"All these things together made the exporters wait and watch. Everybody is expecting the foreign exchange to stabilise. The exporters also will wait till they get good returns for their exports," says Bhandare.

The forex reserves too do not have a lively story to tell. Forex reserves fell by $ 102 million from $ 37.727 billion on May 20 to $ 37.630 million on May 12.

According to Anindya Chatterjee, head of research, ANZ Investment Bank, "Import demand has grown by 15-16 per cent recently and the corporates too are demanding more dollar. The market, thus, turned bearish for rupee."

Agreeing with Bhandare, Chatterjee says, "Besides the import demand, the hike in US interest rate too has played an important role in the depreciation of the rupee. Many FIIs feel it makes more sense to park funds in the US, rather than in the Indian market."

However, Chatterjee feels that as prospects of foreign fund inflows turned negative, the rupee came under pressure."

So where does rupee goes from here?

According to Bhandare, the rupee should settle down at 44.50 against the dollar as there is a state of panic at the moment. However, he said, the fundamentals of the rupee are 'not that bad'.

However, Chatterjee feels that with the tide turning against the rupee, it may touch 44.90-45.00 per US dollar, unless RBI intervenes.

Says U R Bhatt, Chief Investment Officer and Director of Jardine Fleming, "The inflation rate has always had affect on rupee and if one sees the relation between rupee-dollar rate and inflation, the rupee has always weakened against the dollar. So, there is no reason to panic as inflation is one of the fundamental reasons."

The annual inflation rate shot up to a 73-week high of 6.31 per cent for the week ended May 6, on sharp price rise in some food and petroleum products.

The inflation rate rose 0.37 percentage points to 6.31 per cent (provisional) during the week, against 5.96 per cent in the previous week and 3.4 per cent a year ago.

According to reports the current inflation rate, the highest since 6.8 per cent of December 9, 1998 is due to the rise in prices of pulses, rubber, furnace oil and naphtha.

Meanwhile, in a statement, the RBI that it will "continue to sell dollars through the State Bank of India, or SBI, in order to augment the supply in the market, or intervene directly, as considered necessary to meet any temporary demand-supple imbalances." All the RBI transactions will be at the prevailing market rate, the release further said.

ALSO SEE

Rupee closes at all-time low of 44.29/$

Will history repeat itself?

External link: The RBI's statement on forex markets on May 25, 2000

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