The rupee’s recent appreciation to below 60 a dollar — it is hovering around those levels — is a significant development and not just because of its breaching a psychologically important mark. At one level, its recent strength would appear to mirror the changing perceptions of investors, especially from abroad, of the Indian economy. Just over seven months ago, the rupee appeared to be in free fall, touching an all-time low of Rs.68.36 to the dollar on August 28, 2013. Economic fundamentals were weak and, perhaps more importantly, were seen to be so. GDP growth had slipped to a below 5 per cent trajectory from which it has not been able to move up. If despite that the Indian economy is being viewed much more favourably today, the reasons will have to be sought in other economic as well as non-economic factors. Of the former, the most significant one has been the sharp reduction in the current account deficit on top of a satisfactory trade balance. From last year’s unacceptable levels of being over 5 per cent of GDP, CAD is down to an eminently manageable 2.3 per cent during the third quarter of the current year, according to RBI figures. Of the non-economic factors, the expectation of a “business-friendly” government taking office in May appears to have influenced foreign investors to flood the stock markets with relatively cheap money borrowed from abroad. While that has pushed up the stock indices to stratospheric levels, the abundant dollar infusion is driving the rupee up.

From the beginning of this year net investments by foreign institutional investors in debt and equity aggregated $9.5 billion, more than half of it coming in March alone. The rupee’s sharp appreciation poses to the RBI a different set of challenges than what it has been used to. Far from having to defend the rupee by selling dollars — on occasion by drawing down reserves — it is now reportedly mopping up surplus dollars. While that will increase the size of reserves and provide a kind of insurance against currency volatility, the surfeit of rupees released will enhance liquidity and could be inflationary. Determining the correct level of the rupee is always an onerous task, especially when the sharp improvement in CAD is due not to any sustained export revival but to a contraction in gold imports and a fall in non-oil imports. Policy measures to suppress gold imports cannot last for long and have besides led to smuggling. There is really no way out to stabilise the current account except to boost exports, for which a strong rupee will be a deterrent. That said, the current extremely fluid environment makes it doubly difficult to determine the appropriate level for the rupee.

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