The Hindu Business Line : Skidding rupee

A year ago, one US dollar was equal to Rs 40. Now it is equal to Rs 48 — a depreciation of almost 20 per cent. A year ago, ‘experts’ were predicting that the rupee could appreciate to Rs 38, if not more; today they are predicting that it could depreciate to Rs 50 to the dollar. This reveals at least one thing about the foreign exchange market: No one really knows which way it will move. Not only is it a risky market, it is also a highly volatile one. The question therefore for those who use foreign exchange and those who regulate it is a straightforward one. Those who use it have to find ways of reducing their risk by hedging; and those who regulate it have to make sure that the rates are not excessively volatile by calibrating the flow of dollars, as also other currencies, in response to the demand. Since the middle of 2007, after the Reserve Bank of India had indicated that exporters and importers could no longer take for granted that it would be a one-way bet on the rupee-dollar rate, the latter had begun hedging themselves, though not always after fully understanding the nature of cross-currency instruments. And the RBI, of course, has been intervening in the market as usual to curb volatility.

This being so, it seems reasonable to ask what is it that has changed in the last one month that the rupee has depreciated from Rs 44.50 on September 8 to Rs 48.10 now. The easy answer is that the demand for dollars has exceeded supply. It is also easy to say that the near-collapse of the US financial system has led to a sudden spurt in demand from America as firms there scramble for money. But had that been all, it is likely that demand would not have outstripped supply by such a large margin.

Clearly, there has to be some other source of demand — and this is India’s oil companies. Between March and August, they had relied on the oil bonds to get foreign exchange directly from the RBI. But by the end of July they ran out of these bonds and, because the supplementary demand for grants (which would enable a fresh supply of bonds to be issued) has not yet been voted, they are buying dollars in the market. So it seems reasonably certain then that the rupee will continue to be under pressure until new oil bonds are issued as a result of which demand will abate somewhat, though not completely. That leaves the problem of exporters and importers unsolved: at what levels should they hedge?

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