Surge in inflows makes rupee strong

The central bank used to intervene in the forex market (thanks to the RBI purchase of dollars, the forex level is $ 24.87 billion now) when the rupee rises beyond the Rs 35.85 per dollar level. But now the interevention level seems to be Rs 35.70 level. The major factor contributing to the rise in rupee value is the rise in foreign fund flows.

“It’s clear that foreign investment is strong and on the rise. In fact, much of the thrust for moving aggressively towards capital account convertibility (opening up capital outflows) is to assist RBI in managing money supply in the face of these inflows… The rupee’s quiescent performance over the past six months has concealed a wild undercurrent of change in financial markets,” said a study by Mecklai Financial and Commercial Services, a leading forex firm.

According to SEBI figures, net investments by foreign institutional investors (FIIs) in 1997 have been increasing since March. Monthly net FII investment was $ 189.8 million in March 1997, $ 148.5 million in April 1997 and $ 199.6 million in May 1997 and $ 362.9 million in June. As FIIs stepped up purchases the BSE sensex has spurted by over 600 points to 4321.98 in less than a year. “The most exciting story is on direct foreign investment. FDI remains on a high growth path, at least by Indian standards. In fact, these flows have substantially — and consistently — overtaken portfolio investment as a component of foreign inflows,” says the Mecklai study.

Panicky over the steady rise in rupee value, exporters have already pressed the alarm bell. Exporters like Ramu S Deora, who is also the president of FIEO, wants the rupee to be readjusted and dollar rates brought down to Rs 38.40. This, they say, would be necessary if the export targets are to be achieved and to retain a competitive edge in the international market.

Exporters have a point as India has a trade deficit of $ 5.4 billion in the balance of payments account.

However, Mecklai says that exports are certainly important, but at this stage export competitiveness is only secondarily affected by the exchange rate. “Far more significant are issues of infrastructure and interest costs. Exporters need to recognise that their `golden age’ is over — the government can no longer afford to subsidise them,” it says.

The surge in liquidity in the system is likely to put pressure on the inflation levels. As against the RBI target of 15-15.5 per cent in money supply growth, latest figures released by the Centre for Monitoring Indian Economy (CMIE) put the money supply growth at 16.9 per cent as on June 6.

CMIE also attributes the rise in the money supply growth to the heavy inflows of foreign capital. The annual growth rates in forex assets with banks have steadily and rapidy increased from less than 2 % in May 1996 to 37 % in May 1997.

The surplus liquidity at a time when credit offtake is sluggish has not made things easier for the RBI. This means the possibility of a rise in interest rates and inflation will remain two problem areas for the RBI — it cannot afford these two factors to rise — in the coming months. The rupee rise at a time when the central bank and the government are getting ready to make the rupee fully convertible on the capital account is significant.