Once capital account convertibility is implemented, given our strong fundamentals, the rupee can compete with other free currencies to attract investment, both in portfolio and FDI segments.

Our Bureau

Chennai, July 18

Foreign countries may shift a part of their forex reserves to the rupee in future, as they have done with euro now, according to Mr C. Chandrasekhar, Senior Vice-President, Mecklai Financial.

Speaking at a seminar on forex and risk management, Mr Chandrasekhar said "Investors from West Asia and Japan find our political stance neutral and friendlier as compared to some other countries, with a fair degree of stability.

"Once capital account convertibility is implemented, given our strong fundamentals, the rupee can compete with other free currencies to attract investment, both in portfolio and FDI segments. The rupee will not really be a reserve currency. But investment in rupee assets will be on par with investments in Japanese yen (JPY) or Swiss Franc (CHF), and will not entail political risks some times associated with US dollar (USD) or yuan from the standpoint of certain investors."

What about the euro replacing the dollar as a reserve currency? Mr Chandrasekhar said that while the euro is seen as an alternative for USD for holding reserve assets; it was difficult to perceive euro replacing USD as reserve currency in the foreseeable future. He said, "A country with reserve currency would necessarily have adverse balance of payments, sometimes the current account deficit spreading to capital account also. Hence, the economy should be deep enough to sustain large deficits over a long term. I do not think the euro economy is in a position to tolerate deficits, beyond a point. Deficits, when not absorbed, will lead to severe liquidity problems leading to restrictions on convertibility of the currency."

He said, the positive features of US, where EU cannot be a match are, high productivity rates, knowledge resources, overseas assets far exceeding foreign investment in domestic economy, sustained growth rates, low unemployment and highly liquid debt and equity markets.

BoJ rate hike

On the impact of the Bank of Japan hiking interest rates, Mr Chandrasekhar, said, the rate hike will make medium and long-term borrowings in Japanese yen more expensive hence the immediate impact will be on raising ECB in JPY currency.

He said, "the hike is also an indication of stability and growth of Japanese economy and the stimulus of accommodative and expansionary monetary policy is no longer warranted.

"We may, therefore, see their corporate sector becoming more aggressive and competitive."

When asked if the hike would affect the "yen carry trade", i.e., the borrowing of Japanese yen by currency and commodity speculators to invest in other markets, Mr Chandrasekhar said, "There is definitely an adverse impact on carry trade. However, since JPY continues to be relatively cheap, and since speculative trade involves only short-term positions, the carry trade may continue for quite some time."

(This article was published in the Business Line print edition dated July 19, 2006)
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