The rise and rise of the rupee

The exchange rate of the currency of a country in relation to the currency of another country depends on the comparative trade advantages and economic strengths of the countries.. If one US dollar is equal to 45 rupees, it simply means that in the US, if a dollar fetches 45 oranges while in India, a rupee would fetch only one orange of equivalent size and quality. And as the trade advantage and economy of each country improves or deteriorates, the exchange rate of their currencies fluctuates accordingly.

The Indian economy, which does not quite match the US economy, has seen the rupee decline against the dollar over decades. If one compares the rupee and the dollar rates from the '90s up to a couple of years back, one would find that the rupee has consistently fallen by about eight per cent every year. This means that though the US economy was growing faster than the Indian economy, it does not necessarily imply that it was growing fast enough for the rupee to fall by about eight per cent every year. The fall of the rupee in a year could have been more than eight per cent or less if free market forces had been allowed to come into play.

The Reserve Bank of India (RBI), as the central bank of India, which oversees the foreign exchange (forex) management of this country quite often intervenes to ensure that the rupee is adequately propped at a particular rate. This is done to ensure that there are no sudden currency shocks, to protect exporters and importers and above all, to ensure the feeling of 'national pride,' which is attached to a stable and healthy currency.

How does the RBI intervene to prop up the rupee? Today, we are witnessing a surge of dollar-inflows into India. This huge influx causes a significant demand supply gap between the dollar and the rupee and in keeping with the laws of demand and supply, the rate of the rupee, which becomes short in supply vis-à-vis the dollar, rises.

Anything wrong with that? Nothing in the long run, but temporarily exporters are placed at a disadvantage with a rising rupee, since the dollar becomes weaker. Thus a dollar which fetched Rs 48 about two years ago, today fetches only Rs 44 eating into the profit margins of exporters. At the same time, importers benefit, but our economy is at a stage where we first need to build our dollar reserves and so the exporters' woes need to be tackled first.

The RBI, therefore, having set its priority of ensuring more dollar inflows into the country will start buying dollars from the Indian market. This will, once again, bring down the demand supply gap and will, ultimately, hold the dollar at a rate exporters are comfortable with.