The Rupee has come full circle. In the article, “Exports Burn while Delhi Fiddles”, (Economic Times, July 23, 1997) I had argued that the rupee, at Rs. 35.7/$, was the strongest currency in the world, and that the “market” level for the rupee was close to Rs. 41 – a level breached some nine months later. It was suggested that the rupee level controllers at the Ministry of Finance (MoF) and the Reserve Bank of India (RBI) should relinquish control and let the rupee find its own level, much like the happenings in a fish market. Today, the rupee is trading at Rs. 46 to the dollar, instead of being the strongest in the world it is the weakest, and its fair value is closer to Rs. 44 than Rs. 48. The suggestion: the MoF-RBI combine should please decrease control. Some things do change in India, but many, unfortunately, remain the same.

But what about all the poor Indian economic "fundamentals" that has got the media so excited? There is a new expert everyday touting the latest "reason" why the rupee should depreciate. There is the cool authoritative statement by some that the best forecast of the rupee is that it will depreciate by 5 percent every year. That comment has as much merit as stating that not even a child can drown in a river whose average depth is two feet.

"Indian market" wisdom has it that the recent sharp depreciation of the rupee (almost six percent in three months) was the direct result of "market " forces. This is a big lie - and a lie that the MoF-RBI controllers pride themselves in perpetuating. Market forces have as much to do with the level of the rupee as merit and competence have to do with the probability of a politician being elected in India. The rupee is a controlled currency. Nevertheless, it is worth examining if market forces had a role to play in the recent depreciation - and whether, per chance, MoF-RBI is right.

As most market participants know, the change in the value of a currency is affected by changes in the political and economic environment. So what has happened ?  

Oil and Trade : Oil prices and the import bill has doubled. But oil price increases will only affect a currency if the relative growth or relative inflation levels are affected. The Indian economy has to be affected more by oil prices than the economies of South Korea, or Philippines, or Chile. None of the (arm-chair?) experts have suggested that such is indeed the case. Further, total trade imports are up by 23.3 percent during April- June 2000 compared to April-June 1999 - the same as the export growth rate. The trade deficit has widened by $ 500 million dollars. Yawn. The above figures are for trade; service (read software) exports are expanding by $ 500 million each quarter.  

Capital Flows: Foreign direct investment is continuing at its trickle pace because of government inaction - but no different than last year. Portfolio flows, however, are up by $ 800 million this year. And this despite talks of retrenchment by foreigners and withdrawals from other markets (e.g. Korea) whose stock markets have declined a lot more precipitously in 2000 than India's mild decline of 14 percent.  

Fiscal Deficit, Inflation and Economic Growth: While the level of the consolidated (center plus state) fiscal deficit for 1999-2000 was relatively high and rising in 1999-2000 (when the rupee was stable!), the deficit for 2000-2001 is projected by Oxus to be in single digits i.e. an improvement from 11 % of GDP in 1999-2000 to near 9 % of GDP in 2000-01. Tax receipts so far this year are increasing at a scorching 25 percent pace, considerably ahead of the targeted expenditure increase of 13 percent. Even with some excess expenditure growth, the deficit will be narrower in 2000-01 - and this without the revenue gains from a projected oil price hike. So unless we have a new theory of exchange rate determinism - one in which fiscal deficit increases strengthen a currency, and declines weaken - we do not have an economic fundamentals explanation for the recent depreciation of the rupee.

Inflation has edged upwards in India, as it has in the rest of the world. On a longer term basis, the scenario is for further inflation convergence. Indian economic growth is being maintained at a higher level than most of our competitors. So the net effect is for a tendency for the rupee to appreciate!

International interest rates: Some experts contend that the rupee had to depreciate because our 10 percent real rate of borrowing for corporates was too low! Further, that rates had to rise because international (US) rates had risen. Besides the mandarin controlled Fed Funds rate in the US, market determined US rates have all edged significantly downwards in the period when Indian rates have been jacked up. Two year notes are lower by 50 basis points, and the ten-year note lower by 70 basis points from mid-May.

The Indian economy is fundamentally strong, and improving, albeit at an invisible hand (difficult to see) pace. The above should convince all (except the control-hearted) that the rupee's recent depreciation has nothing to do with market forces. Indeed, market forces would have led to an appreciation, and the accumulation of reserves is consistent with this hypothesis. So why the weakening of the rupee ? Because the MoF-RBI mandarins wanted it so. Then why did Dr. Jalan raise interest rates and make the mistake of having one slave (interest rates) serve two masters - economy and the rupee? Because the exchange rate depreciated marginally more than the Babu-Neta mandarins thought desirable.

The above explanation of the change in fundamentals affecting a change in the rupee is crucially dependent on some base level of exchange rate being "fair". If a currency is market determined, such a calculation is unnecessary. The base level is provided by the RBI itself in the form of a 5 country or 36 country weighted real exchange rate. No matter which criteria is chosen, or what base period - 1993 or 1997 June or December 1999 - the Indian rupee has stayed constant (since Dec. 99), or depreciated in real terms by about 5 to 10 percent.

What about political factors weakening the rupee? Political stability enhances the value of a currency. And so it does in most parts of the world. But India, as documented above, is different. Political stability in India means complacent politicians, and party affiliation is quite irrelevant for this conclusion. The BJP is comfortable with its majority, and even more secure in the knowledge that voters have nowhere to turn - and certainly not to the Congress party with Ms. Sonia Gandhi as its leader. The BJP remains confident of staying in power, even if it does nothing.

Which is precisely what it is doing in the economic arena. There has not been a single economic policy initiative which the NDA can claim as its own. True, the pipeline reforms have been undertaken, but that and no more. If the BJP were to even begin to act on financial market reforms (interest rate decontrol and significant moves towards capital account convertibility) and privatization, the rupee will tend to find its own level - and it will be significantly stronger than Rs. 46 to the dollar.