Roaring Rupee

The rupee’s unusual bout of appreciation against the dollar has taken quite a few market-watchers by surprise. Even as forecasters have been raising warning flags, the currency has continued to strengthen, marking a two-year high of 63.6 against the dollar last week. In fact it was RBI intervention which halted this rally. The rupee’s year-to-date gains of 6.4 per cent vis-à-vis the dollar have helped it fare better than rival BRICS currencies such as the Chinese renminbi (4 per cent appreciation against the dollar), the Brazilian real (3 per cent) and the Russian ruble (2 per cent). The strengthening spell has clearly been driven by the incoming flood of foreign investments. Foreign Portfolio Investors (FPIs) have sharply raised their commitments to India this year, making record $19-billion purchases in bonds and sinking another $8.6 billion into stocks until August.

It is certainly tempting to attribute the recent surge in portfolio flows to fundamental factors. Recent rupee gains have been variously attributed to NDA victories in State elections, the renewed reforms push led by GST and the country’s narrowing Current Account Deficit (0.7 per cent of GDP in FY17), apart from the IMF’s rosy growth forecasts. But the truth is that, while these factors may have played a supporting role in keeping foreign investors interested in India, global factors have had a bigger hand. The recent bout of rupee appreciation has been greatly helped by the dollar weakening significantly against a basket of global currencies, thanks to global investors losing faith in the ‘Trump trade’, which has diverted investment flows away from the US market. Emerging markets in general, and not just India, have proved a magnet for these flows due to their relatively high yields and real interest rates. It is thanks to this chase for yield, that India’s bond market has received more than twice the flows received by its stock market.

Yes, a favourable rupee-dollar exchange rate is certainly good news for India from a macro perspective, as it helps shrink the import bill, moderates domestic inflation and gives India Inc respite on input costs. Even export prospects are not likely to be materially dented by the appreciating spell, given the synchronous gains in other currencies — year to date, the euro is up 11.8 per cent against the dollar and the Japanese yen has gained 6 per cent — and the commodity component in India’s export basket. But at the same time, the factors behind the recent rupee strength suggest there is no room for complacency. The recent winning streak for the rupee has been accompanied by reports of importers choosing to leave their exposures unhedged, and foreign currency borrowers celebrating the reduction in their liabilities. Fiscal mathematics that factors in a strong rupee can also turn awry if the tide turns. In short, both the Centre and India Inc can celebrate the roaring rupee, but they cannot afford to take it for granted.

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