The rupee plunged breaching the psychological barrier of 50 a dollar amidst a mood of negativity in the economy. The uncertainties in the global economy are stronger today than in 2009 when the rupee moved to similar low levels against major currencies.

The rupee closed at 50.02 a dollar last Friday after touching a 30-month low of 50.32 intra-day (lowest since April 28, 2009). Meanwhile, the Reserve Bank of India fixed the reference rate for the dollar at 50.0670.

More than a month, domestic foreign exchange markets were testing low levels the rupee could reach against the dollar. Markets expected the central bank to intervene to check the fall of the rupee. But instead of doing so, it allowed the rupee to decline gradually ensuring no volatility affecting the market. The RBI Deputy Governor Subir Gokarn had reportedly said in early September that the central bank would intervene in the foreign exchange market if the falling exchange rate of the rupee disrupts real sector.

In the current month, the rupee has weakened by more than 2 per cent. For the quarter ended September, the rupee's value diminished by 8.8 per cent. Further, the rupee was worst performer among its major Asian peers in 2011.

Futures trading

Last Thursday, spot rupee opened at 49.42 and traded at a low of 49.81 and a high of 49.3650 before closing at 49.8050. In the futures trading too, the rupee moved down sharply on Friday against the dollar from Thursday's level. On Thursday, the dollar-rupee October month contracts opened at 49.4825 and recorded a low of 49.8950 and a high of 49.44 before closing at 49.88. On Friday it opened at 50.1050 and moved to a high of 50.3850 and a low of 50.0300 before closing at 50.0825. However, in the November contracts, it opened at 50.37 and touched a low of 50.28 and a high of 50.61. It closed at 50.3750 for the week. Markets expect further fall in the exchange value of the rupee against U.S. dollar.

There were several reasons for the fall in value of rupee against the dollar. First, there is a strong demand for dollar as no one is able to predict an end to the European debt crisis.

The crisis, which started from Greece, is now spreading to other European countries. Meanwhile, the two largest economies of European Union, Germany and France, caught into a tussle on how to resolve the problem.

Importing inflation

While France suggested the use of more European central bank money to fight the eurozone debt crisis, Germany and other EU partners resisted this move. This uncertainty leads to higher demand for dollar in the foreign exchange market. For India, falling rupee means importing inflation, which is hovering at higher levels, more than the central bank's tolerable expectation. India's highest import is oil which is around 80 per cent of the total demand for oil. Oil import bill stood at $79.55 billion in 2009-10 and increased to $106 billion in 2010-11.

As per an earlier estimate, the oil import bill is estimated between $120 billion and $130 billion in the current fiscal year.

Further, oil accounts for almost one-third of the total imports. At present, Brent crude oil prices are moving between $109 and $110 a barrel. So the huge demand or ever-increasing demand for oil will definitely compound the inflationary pressure.

Current Account Deficit

Other than persisting inflation, the increasing Current Account Deficit is another concern. India's current account deficit (CAD) widened in the April to June quarter largely due to a rise in trade deficit. CAD stood at $14.1 billion in the first quarter of current financial year compared to $12 billion in the corresponding quarter of the previous year. It was at $5.4 billion in the January to March quarter of 2011.

Goods exports recorded a 47.1 per cent growth while imports registered a growth of 33.2 per cent during the first quarter of the current fiscal. The trade deficit on Balance of Payments (BoP) basis, in absolute terms, amounted to $35.4 billion, which was higher than $32.3 billion in the corresponding quarter of 2010-11.

Net exports of services grew by 19.1 per cent during the first quarter of 2011-12 as compared to the first quarter of 2010-11. According to the RBI, however, there was a net accretion to foreign exchange reserves of $5.4 billion in the first quarter of 2011-12 (excluding valuation).

The U.S. and European Union are the biggest importers of Indian goods. Exports were growing but the European crisis will have a negative impact on Indian exports.

“If oil and commodity prices remain elevated, the CAD will remain significant,” said RBI in its annual policy statement for 2011-12. It also admitted that financing of CAD was going to be a challenge as advanced countries begin exiting from their accommodative monetary policy stance. This could slow down capital inflows to emerging market economies (EMEs), including India, as investors rebalance their portfolios. The RBI has always maintained that it will not target any specific exchange rate for the rupee.

Further, the central bank said that it would not use the foreign exchange rate for its inflation management. It will only intervene to prevent excessive volatility.

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