The Hindu Business Line : Rupee comes into its own

Quite possibly, the rupee's abrupt and unchecked rise could signal a shift in policy. The authorities are keen to bring down the inflation rate to 4 per cent levels, but are stymied by the relentless increase in world oil prices.

IT has been a dramatic week for the rupee. After a prolonged period of narrow trading around Rs 45.25, it suddenly shot up to Rs 44.06 on Monday, in the space of four trading days. While such sudden breakouts are not uncommon among major currencies - dollar/yen and Euro/dollar - it is extremely unusual for the rupee.

The RBI has generally kept the exchange rate in its tight grip. Till two to three years back, the pressure on the rupee was very much on the downside. While the Government and the RBI generally favoured a weak currency, they did not want the fall to destabilise the real economy and financial markets.

Hence, the central bank did intervene on occasions to prevent too rapid a depreciation of the domestic currency.

It is only in recently that the rupee has started showing sustained strength. The reasons are several.

The Indian economy is coming out of the woods and woodwork.

Apart from the well-known success of software and pharmaceuticals, some others of our manufacturing (and non-manufacturing) sectors are emerging in international markets. The extensive restructuring and emphasis on being able to compete globally have transformed the prospects of quite a few Indian companies and along with that, the economy.

All these things have, of course, not gone unnoticed among global business and fund managers.

There has been a huge surge in both foreign direct investments (FDI) and foreign institutional (portfolio) investments (FII) in the stock market.

Also India's elevation to investment grade by one of the two leading credit rating agencies in the world - Moody's — has attracted money into the debt market, helped in no small measure by the wide interest differential between India and the US and the negligible cost of hedging currency risk.

It is no surprise, therefore, that capital inflows have overwhelmed the forex market and exerted enormous upward pressure on the rupee.

The RBI has tried valiantly to curb the rupee's rise with little success. In this, it is handicapped by the relatively high domestic inflation, which forces it to keep interest rates high and in turn attracts more "hot" money.

Does the rupee's abrupt and unchecked rise signal a shift in policy? Quite possibly.

The authorities are keen to bring down the inflation rate to 4 per cent levels, but are stymied by the relentless increase in world oil prices.

Allowing the rupee to appreciate and bring down energy prices in rupee terms may have a positive impact on inflation.

This, in turn, will enable the central bank to cut interest rates and make India less attractive as merely on arbitrage destination for debt funds exploiting the interest differential and forward discount on the rupee.

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