The Indian Rupee-US Dollar Exchange Rate: The Economic Impact of a Strengthening Currency

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"The profitability of exporters has been wiped out and constant appreciation is threatening the competitiveness of our product. If we lose the market, aggressive competitors are just sitting on the fence to occupy the market."¹

- G.K. Gupta, President of the Federation of Indian Export Organizations (FIEO),² in October 2007

"The government is concerned over the rapid appreciation of the rupee against the US dollar and the central bank may have to intervene if there is disorderly movement in the exchange rate."³

- P Chidambaram, Finance Minister of India, in September, 2007

"The objective of the exchange rate management has been to ensure that the external value of the rupee is realistic and credible as evidenced by a sustainable current account deficit and manageable foreign exchange situation. Subject to this predominant objective, the exchange rate policy is guided by the need to reduce excess volatility, prevent the emergence of destabilizing speculation activities, help maintain adequate level of reserves, and develop an orderly foreign exchange market."⁴

- RBI's Policy in the Foreign Exchange Market

Introduction

In April 2007, on the back of a rising rupee, the Indian economy became a trillion dollar5 -economy, moving the country into an elite group of nations (Refer Exhibit I for the List of Trillion Dollar Economies). By August 31, 2007, the Indian currency was trading at 40.96 against the dollar, as compared to 46.55 on August 31, 2006, an appreciation of around 12 percent (Refer Exhibit II for Rupee-Dollar Exchange Rate Movement from August 2006 to August 2007). The rise in the value of the rupee was a result of the general weakening of the dollar in international markets, plus India's growing attractiveness to foreign investors.

In 2006-07, India attracted huge capital inflows in terms of foreign direct investment (FDI),⁶ and foreign institutional investment (FII).⁷ External commercial borrowings (ECB)⁸ and non-resident Indian (NRI) deposits and remittances also contributed to the dollar inflow.

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1] "Exporters Seek Government Intervention on Rupee Rise," www.newspstindia.com, October 1, 2007.

2] The Federation of Indian Export Organizations (FIEO) is a non-profit organization set up by the Ministry of Commerce, Government of India in 1965, to coordinate and focus the efforts of organizations engaged in export promotion in the country. (Source: http://fieo.org)

3] "Rapid Rupee Appreciation is a Matter of Serious Concern: FM," www.newindpress.com, September 27, 2007.

4] T.C.A. Ramanujam, "Currency Crossfires," www.thehindubusinessline.com, June 27, 2003.

5] Dollar ($) denotes US dollars in this case study.

6] An investment made to acquire lasting interest in enterprises operating outside the economy of the investor is called foreign direct investment (FDI). (Source: http://en.wikipedia.org)

7] Foreign institutional investment is a part of foreign portfolio investment which involves holding securities such as stocks, bonds, or other financial assets by foreign investors. In India, foreign institutional investors have to register with the Securities and Exchange Board of India (SEBI) to participate in the market. There are limits on the ownership by foreign institutional investors in Indian companies.

8] ECBs include bank loans, suppliers' and buyers' credits, fixed and floating rate bonds (without convertibility) and borrowings from private sector windows of multilateral financial institutions such as International Finance Corporation. (Source: www.banknetindia.com)