Finance Minister Pranab Mukherjee may not seem too perturbed by the Rupee’s appreciation against the US dollar but the recent surge in the former has vexed many.
Foreign Institutional Investors (FIIs) have been primarily responsible for the stock market’s recent bull run. Particularly, the month of September has seen the Sensex breach the 20,000 mark for the first time since 2008. However, Rupee appreciation is one concern that haunts the market.
FII funds get converted into Rupee in order to trade in the stock market, but end up chasing the Rupee. The Rupee has appreciated by 6.3% in the last two months. The Rupee, which was hovering around 47 per dollar, fell below 44 a fortnight ago and closed at 44 levels. In fact, the Rupee was at a 25-month high in the beginning of this month.
Nevertheless, the newfound confidence in the Rupee does not illustrate a rosy picture.
In the run up to an immaculate growth story, an unhinged and impulsive currency hike has pushed the market to a state of trepidation. The Indian export sector is one segment that has to bear the greatest brunt of the Rupee surge. Market pundits have also expressed their apprehensions about the rising spree of the Rupee.
The Indian textile sector, in particular, has been languishing ever since the Rupee began its surge. The textile industry, which is already grappling with a reduction in duty drawback rates and swelling yarn prices, has now been burdened with a boost in the Indian currency. The apparel exporters’ response to beat the wearing issues has been to hike rates.
This move might affect buyers, but exporters seem to have no options left. Many exporters have also been instructed to increase the price of garments by 25 percent in line with countries like Bangladesh, China and Vietnam. With the price of cotton hitting an all-time high of USD 1.19 a pound in the international market this month, Bangladesh and China have sensed trouble. These two countries heavily depend on cotton imports for their textile industries.
The swing in Rupee might worsen the already poor situation in the garment sector, with exports having declined by 7-8 % from April onwards.
At this juncture, the market can only look to the Reserve Bank to intervene in the forex market so as to have a calming effect on the macro-economic situation. Though the RBI has hinted at intervention to moderate the Rupee swing, the fear of inflation isn’t helping matters. It is a case of being caught between the devil and the deep sea. If the RBI goes on to intervene in the forex market, it will end up infusing liquidity in the system which in turn will supple interest rates.
And once liquidity topples, it is bound to boost inflation from the 8.62 percent recorded in September.
Moreover, RBI Governor D Subbarao has said that the central bank will intervene if the required: “We are watching the situation and our policy is clear. We will intervene if (FII) inflows are lumpy and volatile,” he had said.
Since the government is showing no interest in fixing the price of Rupee as of now, a check on the inflow of FII funds can be of great help. This is one solution that is unlikely to backfire.