It's time RBI bit the bullet

Unprecedented fall in the rupee has little to do with the currency’s fundamentals.

If dealing with high-interest rates and raging costs was not bad enough, corporate India now has a free-falling rupee to battle. What has irked India Inc the most is not just the unprecedented fall in the currency, but the central bank’s rather brazen non-interventionist stance. Says Samiran Chakrabarty, head of India research at Standard Chartered Bank: “The market will wait for guidance from the central bank on when and where the slide will stop.”

Interestingly, ever since the trade data for October came out, showing a hefty trade deficit of $20 billion against a usual $10 billion, the rupee has started sliding. However, forex traders say there is no major demand for dollars. Secondly, foreign investors are not selling either, as they have been net buyers of equities in October (Rs 2,469 crore) and November (Rs 120 crore).
 

INCONSISTENT RUN Based on Real Effective Exchange Rate
Date	6-country	36-country
	REER	REER	$ vs INR
Jan-11	117.46	103.78	45.41
Feb-11	115.7	102.71	45.44
Mar-11	116.44	103.28	44.98
Apr-11	118.78	104.94	44.37
May-11	117.74	103.03	44.93
Jun-11	117.48	103.82	44.85
Jul-11	119.14	104.94	44.42
Aug-11	116.9	102.93	45.32
Sep-11	113.67	100.13	47.68
Oct-11	109.08	Na	49.25
Nov-11	Na	Na	50.20
Source : RBI

So, what is causing the rupee to go into free fall? The first one is that over the last one year, the Real Effective Exchange Rate (REER) has been moving up. The central bank measures India’s competitiveness in the export market by measuring nominal exchange among different countries after adjusting for inflation. There are two such rates, one is a six-country basket and the other a 36-country basket.

The six-country REER has been inching up steadily from 107.33 in January 2010 to 116.90 in August. The 36-country REER, which matters more, stood at 102.93 in August. Chakraborty explains that REER looks at the rupee as a trade measure. “For a country like India, where the capital account has a surplus compared to the deficit in the current account, this measure cannot be the only determinant in arriving at a fair value of the rupee,” he says. And even if you look at REER, the one that really matters is the 36-country exchange rate, it stood at 100.13 in September. Another popular theory justifying the fall in rupee is the Net International Investment Position, which is the sum total of forex liabilities of a country compared to its forex assets. India’s assets stand at $435 billion, while liabilities stand at $669 billion. However, economists are unanimous in their belief too that in a growth economy, this is not a major issue.