There isn’t a better indicator of macroeconomic stability and investor confidence than the exchange value of an economy’s currency. It is, therefore, significant that the rupee has strengthened to below 60 to the dollar for the first time in eight months. This is a major turnaround especially when one considers the period between July 30 and August 28, which saw the rupee fall by 12.5 per cent to a low of 68.36 to the dollar. The rupee’s recovery since then has further been attended by a swelling of the Reserve Bank of India’s (RBI) foreign exchange reserves by over $ 23 billion to $298.6 billion — the highest since December 23, 2011. The fact that the RBI is now a net buyer of dollars — and has even stopped supplying forex to oil companies through a special swap window it had opened late last year — reflects the sheer improvement over the last six months or so.

Three factors explain the change in the rupee’s fortunes, from a victim of ‘shorting’ to being the best-performing emerging market currency after the Indonesian rupiah this year. The first is the sharp fall in India’s current account deficit from $21.8 billion in April-June 2013 to $5.2 billion and $4.1 billion in the subsequent two quarters, resulting in reduced drain of dollars from the system. Second is the mobilisation of some $34 billion of non-resident deposits and overseas borrowings by banks, against a concessional swap facility offered by RBI. The third factor is foreign institutional investor (FII) flows. FIIs have so far made about $9.5 billion in net purchases of Indian equities and debt, of which $4.6 billion came in March alone. Much of this has been due to perceptions of India’s improved macro stability — relative to other emerging economies and also to itself not so long ago — and the expectation of a stable, market-friendly government being formed two months from now.

The RBI should use the current situation to keep buying dollars. This will help further bolster its forex reserves, thereby buying insurance against potential capital outflows in the event of any adverse election results. Secondly, such purchases will prevent any undue appreciation of the rupee from the existing levels that could hurt the competitiveness of Indian exports — one of the few sectors in the economy still registering some growth. Thirdly, the RBI is unlikely to reduce interest rates in its next bi-monthly monetary policy review on Tuesday. While the Central bank may want some clarity on the next government before embarking on such a course, the infusion of rupees from its dollar purchases would significantly improve liquidity in the domestic money markets. In the current weak investment environment compounded by the continued squeeze in corporate margins, this could well have a salutary impact.

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