The soaring appreciation of the Indian Rupee in the recent past has been unprecedented, with a major contributing factor being the massive inflow of Foreign Institutional Investor (FII) funds, surpassing $23 billion in the current calendar and still increasing. The country's rapid economic growth and rising interest differentials with the West, following easy monetary policies, have attracted significant capital inflows in pursuit of higher returns. This influx has led to a sharp appreciation of the Rupee, making the US dollar cheaper in comparison.

India is now facing the possibility of foreign funds transforming from trickles into a flood, resulting in excessive availability of funds in the stock market and impacting the value of the US dollar against the Indian Rupee. The Rupee has appreciated by a substantial 7% between early September and the second week of October this year. While the trend of currency appreciation is not the primary concern, the speed of the Rupee's surge has raised alarms. Such sharp movements can disrupt markets and surprise stakeholders, necessitating intervention.

Garment exporters are particularly affected by this situation, facing challenges from multiple factors, including the double blow of Rupee appreciation. The increased Rupee prices of their products translate into higher dollar prices, reducing competitiveness in the export market and resulting in smaller Rupee profits from dollar earnings. Exporters are grappling with reduced duty drawback rates, escalating yarn prices, its dwindling availability in the domestic market, and the recent Rupee appreciation.

According to industry leaders, the Rupee might continue to strengthen, reaching levels of ₹43 to a dollar. The sudden influx of half a billion dollars in a week has left uncertainties, with even the Reserve Bank of India (RBI) unsure how to proceed. The roll-back of duty drawback and a special incentive of 2% has further impacted apparel exports, causing disruptions in quotations and prompting requests for price increases or order cancellations.

Rakesh Vaid, President of the Garment Exporters Association, emphasizes the need for immediate RBI intervention to manage currency exchange rate fluctuations caused by the surge in capital inflows. He calls for an effective exchange rate management policy and careful assessment to ensure that financial flows do not adversely affect exporters. Sharad Kumar Saraf, Vice President of the Federation of Indian Export Organizations (FIEO), advocates for a mechanism to exclude "hot money" contributing to rapid appreciation and prevent distortions in the exchange rate. The industry expresses concerns about potential employment impacts if the trend continues.

Govt. Effective Intervention Waits for Lumpy and Volatile Inflows


In fairness, it must be acknowledged that RBI did try to intervene, of course, half-heartedly when it stepped into the market to buy dollars when the Rupee rose to 44.10 against the dollar, which immediately nudged the Rupee down from a 25-month intra-day high to `44.25. It is understood that RBI's intervention was of the order of $400 million. This was, however, in addition to the State-owned oil companies buying dollars worth $1 billion, taking the total market intervention to $1.5 billion. But that was a short-term, even half-hearted intervention.


According to official sources, the Government is comfortable with Rupee between 43 and 45 toe US dollar. The Rupee has climbed 3.5% to be Asia's second-best performer outside Japan in the past month, as foreign fund flows into the nation's surging stock market reached a record $23 billion this year. It is understood that RBI might intervene to weaken the Rupee and protect exporters, if the currency appreciates past 43 against the US dollar. Subir Gokarn, Deputy Governor RBI said that RBI might sell the Rupee to curb gains in the currency. However Governor D. Subbarao said that it is only "lumpy and volatile" dollar inflows that would attract intervention.


Will we have to wait for a crisis to develop?


RBI Intervention For and Against


First, as to why RBI should intervene. India is probably the only major developing nation in the world today that is still holding back from restrictions on fund flows, despite growing concern that they are hurting exports and boosting imports. With the reported consideration of another relief by the US, "there is a good chance that funds will be diverted to Indian market" said Hemant Mishra, MD and Head global Marketsat at Standard Chatered Bank. He added, "However, if there is a stampede, authorities will be selective in controls, like say sectoral cps on capital flows."


There have been growing shrill voices in favour of RBI intervention. Those who have been on the vanguard seeking RBI intervention are the industry leaders like A. Sakthivel, Rajinder Hindujua, O.P. Oswal and Rakesh Vaid. These and other industry leaders have maintained that several countries, who are feeling the heat of worldwide global downturn, did demand and secured the Government intervention.


It also needs to be recognized that near-zero interest rates in the developed world and another dose of quantitative easing in the US have created the risk of large inflows flooding emerging markets with better growth prospects. According to Citi, "Asia faces a growing risk of excessive capital inflows." It expects India to take some measures to curb flows, stating, "We expect the bias now could be towards tightening of inflows." In this case, it quotes that Brazil has already imposed a tax on capital inflows to discourage disruptive forex inflows.


The garment exporters insist that when a number of governments have intervened, why can't India, and quote that Thailand has joined Brazil and Korea in imposing curbs on overseas inflows that were distorting their trade when the US seems set to ease controls and China is sticking to its stand on near-fixed Yuan exchange rate. China has also removed a 15% tax exemption for foreigners on income from domestic bonds. Brazil has doubled the taxation on overseas flows and Korea said it would start an audit of lenders handling foreign currency derivatives. Surjit S. Bhalla, Chairman of Oxus Investments

said, "Everybody is intervening, be it Korea, Brazil or Japan. Only we seem to be quite sanguine. In that sense, we need not worry. It is not in the interest of our economic growth to have the Rupee so high. Therefore, we should be intervening to keep it stable. That is what other countries are doing. It is a lot more difficult for Japan to intervene as it has an open capital account. For us, it is a closed capital account, so it I easy to interview. That is how China manages to do it; so do Brazil and Korea."


However, RBI is clearly under pressure to intervene. Ajay Shah, Professor at NIPFP argues for a measured approach. He said, "until early 2007, RBI was actively trading in the currency market, championing the cause of India's exporters and we saw how much trouble it got them in."


While dollar inflows are an issue, economists have also their eye on the trade deficit which is expected to cross $130 billion in the current fiscal year. With commodity prices on the rise and the local economy growing at a fast clip, the deficit could widen further because of poor demand in the developed world. The current account deficit is headed to 3% of the Gross Domestic Product, which is the highest in nearly last two decades.


Alternative to RBI Intervention


Since RBI's intervention cannot come so easily some of the exporters have made some suggestions. It is understood that Tirupur exporters have been suggested to increase their export prices by 25%. Sakthivel says, "Slowly, buyers will agree to the increased amount as competing countries like China, Bangladesh and Vietnam too have increased the prices of their products due to high prevailing cotton price in the international market." However, Coimbatore-based Ambika Cotton Chairman and MD P.V. Chandran said exporters should look at options like packing credit against export order in dollar terms so that the fluctuation of Rupee against dollar will not affect the outcome of the business. Raja M.Shanmugham, Managing Director of Warsaw International, Tirupur said, "The steep falls and recoveries have only added insult to the injuries. Today, there is no point applying logic. We only need to be more watchful and book forward cover for our products on a month-to-month basis to escape all uncertainties."


Excessive Inflow of Foreign Funds


The moot point is whether RBI intervention is required or not in the face of massive inflow of FII funds. In this context, it would be necessary to refer to the discussions currently going on in US Central Bank, the Fed, on the possibility of releasing another massive flood of dollars into the economy to fight the sluggishness in the US economy. This would be the second round of QE (the first round came in, in the wake of financial meltdown of 2008, when the Fed had pumped in roughly $ 2.4 trillion. This would mean that the Fed is likely to offer a massive and almost zero-interest loan to US global investors who can use it to buy assets that offer much higher returns in emerging market stocks or commodities. India, as the second fastest developing economy in the world and with a stabilised equity market would be a great attraction for investment. Thus, there could be a massive inflow of foreign funds in India.


G.S. Bhalla says, "I do not think we should try and curb any of those. FII, FDI none of that. Inflows are not a problem. We need inflows. Even if we prevented the Rupee from appreciating, we will still get the inflows. You had the inflows when you had the Rupee at 40 and even when it was at 53." Yet everybody is asking for intervention by RBI, without any further loss of time.

How This Inflow Should be Checked?


What can be done to check the tide of cheap dollars? This problem, as a matter of fact, is not only confined and limited and conspicuous only to India, but other emerging economies also faced the similar problems and they have dealt with it in their own way. For example, Thailand recently introduced a tax on foreign investments in bonds and South Koren has followed suit. Brazil had imposed a similar tax on bonds earlier and it recently doubled its rate.


Similar options are available to India as well, which could act slap a tax on capital flows or could go in for measures that are less visible like by weakening existing regulations like the curbs on Participatory Notes. In the interim, RBI could certainly consider and buy dollars from the market to prevent excessive appreciation of Indian Rupee, which is indeed a cause of serious worry and anxiety not only on the part of Indian exporters, particularly the garment exporters, but also to the Government in view of massive trade deficit of $ 130 billion, which should not a mean concern.


I personally feel that we should tax the short-term FII investments that have been quick to runback for cover on the slightest indication of scripts not doing well. These are fair weather friends, but play the role of villains. Once they are curbed in their hot pursuit of "hot profits" by their fly-by-night practice, I think the present soaring levels of appreciation of Indian Rupee will climb down, much to the relief of all stakeholders, including the Government.

 

Views presented here are those of the author.