Rupee could fall to 47/dollar by FY11 end

“An appreciating currency is as deflationary as a hike in interest rates,so whether it is that,or whether it is being driven by Delhi,we don’t know. But whatever it is,we are doing a disservice to the broader economy,” Rajwade said.

The real appreciation in any currency can be measured through the Real Effective Exchange Rate (REER),which is a weighted average of a country’s currency relative to an index or basket of other major currencies adjusted for the effects of inflation.

Rajwade said the rupee could retreat to 47 per dollar by the end of March 2011. By comparison,a Reuters poll at the end of last month,forecast the rupee would appreciate to 43.5 at the end of India’s current fiscal year.

He attributes his bearish rupee view to three factors: “a further worsening of the current account deficit,possibility of a change in the RBI’s exchange rate policy,and FIIs (foreign institutional investors) reviewing their outlook on the Indian corporate sector’s profitability.”

The rupee hit a record low of 52.2 against the dollar in early March 2009 and has since then recovered to 44.4 as of Tuesday,a 17.6 per cent gain.

“I do not recall any comparable period when such appreciation has happened,and that too at a time when the dollar itself has risen against other currencies,” he said in an interview.

“If the flows are there and if you allow the rupee to go where it will,then even double the flows are manageable because the RBI just sleeps over it. But it is a very bad thing to do and it is very dangerous,” he said.

Rupee gains have been spurred by foreign capital flows into Indian stocks. Net portfolio investments so far this year have crossed $6 billion,on top of the record $17.5 billion that entered the market in 2009.

The central bank refrained from intervening in the foreign exchange market for the three months from December to February,despite a fair amount of volatility during that time,the latest data shows. Data for March is not yet available.

“Whether this is a shift in their exchange rate policy,it is difficult to say but what one suspects is whether they are looking at exchange rate as an anti-inflationary measure,” Rajwade said.

The central bank maintains a stance that it does not use the rupee as a monetary management tool and intervenes in the market only to curb excessive volatility.

Headline inflation reached 9.9 per cent for March,and the RBI raised key interest rates by 25 basis points in March and again in April,with further hikes expected.

Central bank monetary policy is widely seen as being influenced by the federal government,which favours pro-growth policies and always wants to manage the cost of its borrowing.

CAPITAL CONTROLS TO PREVENT RUPEE RISE

Both the government and the RBI appear reluctant to use direct capital controls on foreign portfolio inflows,which they regard as an opportunity.

However,the RBI said last week that if inflows were to rise sharply,it could pose a challenge to monetary management.

Rajwade said the RBI should intervene in the market to prevent the rupee from rising to unsustainable levels and could resort to issuing market stabilisation scheme bonds or a hike in the cash reserve ratio (CRR) for banks to sterlise the resultant liquidity infusion.

“If CRR is not to be resorted and cost of sterilisation is high,then the simplest way is to put controls on capital inflows,particularly on the money coming into the stock market,” he said.

Rajwade suggested asking foreign funds to set aside 10 per cent of all fresh inflows with the central bank for one year without interest as a way of taxing the investments.

“We control foreign direct investment (FDI) so much more,FDI which directly creates investments and adds to jobs. We control that,but not the money which is merely coming into stocks and doesn’t add to any productive purpose. So if necessary and if capital controls is the only way out,then it should be done.”