Rise of Rupee

Rupee has risen to a 9-yr high vs the dollar and is trading around 41.7 per $. In an ideal world the rise of a currency is seen as a good thing. Currency appreciation indicates growing economy, current and fiscal accounts show healthy signs. But this may not be strictly true for India.

Let's look at the impact of currency appreciation more closely. When currency appreciates it is beneficial to the importers as they have to pay less in Re terms for the import. For exporters the reverse is true. Falling currency make their products more expensive. And as a product becomes dearer the sales start to decrease.

India's technology and BPO sector is an export fast growing sector. Most of the jobs are being created in the sector. So, anything which hurts this sector will in turn have an affect on the Indian economy. Therefore, everyone expects RBI to intervene to stop the rise of the Re. However, RBI is more concerned with the rising inflation.

So how does currency appreciation impact inflation. The current rise in inflation is caused by rise in food and fuel prices. India imports its fuel and rising Re will in turn lower the actual price that is paid for these imports. Secondly, as India seeks to import food grain to meet the shortage in food as rising Re will only help.

Therefore, if the import costs are lower then the final retail prices should also be lower. This explains the reluctance of RBI to intervene. They are trying hard to get the inflation in their target zone (ard 5%).

Moreover, even though Re has seen high appreciation in dollar terms it has seen only a slight rise in terms of other currencies (yen, euro, pound). This seems to indicate that the rise can be attributed more to dollar's broad decline against all other currency.

In conclusion, though rise in currency is generally a good sign, the current rise in Re may be due to factors other than the health of the economy / fiscal discipline. This rise has led to various reports indicating that the Re is overvalued by as much as 13-14% and will eventually fall back to 43.5 - 44 range.