Although the rupee has been on a downslide in relation to the dollar for quite some time, the extent of depreciation has been particularly striking recently. On Monday, the rupee fell to below its all-time low of Rs.51.97 (reached in March 2009) when it breached Rs.52 during intraday trading. On November 18, it closed at Rs.51.33. The home currency's fall is mirrored by the sharp drop in the benchmark stock indices, the Sensex and the Nifty. Both lost 5 per cent during last week. According to SEBI, there was an outflow of $254 million from the domestic equity and debt markets, attributable to concerted selling by foreign institutional investors. A combination of domestic and global factors is behind the rupee's fall. Economic growth is slackening.
The widening current account deficit and the critical reliance on short-term capital flows to bridge it are adding to the pressure on the rupee. Recent export figures have dashed hopes that exporters would continue their sterling performance of the first seven months and help in containing the merchandise trade deficit. The sharp demand contraction in the traditional export markets — the United States and Europe — has begun to take a toll. A depreciating rupee makes India's imports costlier. Many items, notably petroleum, have an inelastic demand. The import bill is bound to go up steeply. Moreover, the falling rupee has offset the recent declines in the prices of certain imported commodities. On the other side, exporters who normally stand to gain say that they did not quite expect the rupee to slide so precipitously. Anticipating a further decline, many exporters are holding on to their proceeds, while importers have been rushing to buy dollars to cover their imports. What is intriguing is the Reserve Bank of India's rather passive stance in the face of such large declines in the home currency. It is possible that, in its assessment, the size of forex reserves is not large enough to defend the rupee in what promises to be a period of prolonged uncertainty and financial market volatility. Or else it wants to conserve its fire-power for future contingencies that may warrant aggressive intervention. Either way there is a strong case for the RBI to communicate its stance to the markets proactively. Its only significant policy initiative with a bearing on the exchange rate has been to increase the ceiling for FII investment in corporate and government bonds by $5 billion in each category. The expectation is that debt flows to India will increase and that would relieve the pressure on the rupee to some extent.
