On Thursday, the Union Cabinet approved, among other things, raising the limit for foreign direct investment in the insurance and pension sectors to 49 per cent. In anticipation of this and other changes, the stock markets had boomed, pushing the bellwether BSE Sensex over 19,000.
Most of the investments came in through foreign institutional investors, increasing the supply of foreign currency which strengthened the rupee to below 52 to a dollar, from over 57 just a few weeks earlier. The sharp rise has sent worry signals to many stakeholders, especially exporters.
Rafeeque Ahmed, president, Federation of Indian Export Organisations, says such a sharp rise in the rupee would affect exports and many from the small and tiny sectors would feel the pinch, as most of their exports are unhedged for currency risk. Beside, in such high volatility, the exporter is not in a position to fix prices on the appreciated value and would wait for a little depreciation before booking orders. He wants the Reserve Bank (RBI) to intervene and curtail the high volatility, while allowing the rupee to move freely.
A V Rajwade, a leading foreign exchange and risk management consultant, says in the absence of central bank intervention, the real exchange rate can appreciate even as competitiveness declines (as evidenced by the widening deficit on the current account), because of high capital inflows, has been the case in India in recent years. The problem with ever widening deficits is that the music of capital flows stops playing some day and a crisis results. On exchange rates, we probably need to learn more from Beijing than from Chicago, which has become synonymous with market fundamentalism, he says.
The Friday editorial in Business Standard also asks: When the current account deficit is so high, and well into the danger zone, how can the currency be allowed to appreciate unchecked? It says a rupee that increases in value will push up the domestic demand for oil and decrease the competitiveness of India's exports, worsening the current account deficit. It says RBI cannot sit on its hands; it will have to step in, sell rupees and buy dollars, thus building up reserves and keeping the rupee from appreciating too fast and anchored to fundamentals not too far, in other words, from the range prescribed by RBI's calculations of the real effective exchange rate.
A few days earlier, Arun Shourie warned about the perils of single point fundamentalism. Right now, the central government seems focused on attracting foreign capital inflows and RBI seems bent on reigning in inflation.
The broader effects on loss of competitiveness of exports, surge in cheaper imports, consequent loss of job opportunities and lower growth rates seem to get lesser attention. RBI needs to quickly re-look at its reactive policy of allowing markets to determine the exchange rate and intervening only to curb excessive volatility. It needs to get pro-active and ensure exports do not get uncompetitive. The commerce ministry needs to cut transaction costs for exporters.