Why is the rupee falling?
The rupee continued to fall for the fourth week in a row and this time, it touched record lows. On Friday morning, it touched an all time new record low when it breached the 46 mark against the Greenback and was quoting at 46.08 on Friday morning. The rupee was more or less stable since the beginning of this year except for some hiccups here and there. But why this panic suddenly? Why the downhill journey of rupee is not coming to an end?I would like to explain it in what I will call a Spillover effect, that is, one thing leading to another. It all started when Mr. Alan Greenspan, Chairman, Federal Reserve, USA, increased the interest rates in the US economy thrice in just over six months. The interest rates in the US were at their record highs in the recent past. This prompted the FIIs to liquidate their investments in the Indian equity markets and park their funds in US markets, where there is no exchange rate risk for them.
This is also the reason for continuos fall in Sensex. The FIIs were net sellers in the Indian equity markets to the tune of $315 million in July alone. This suddenly increased the demand of Dollar in the forex market, which started a sort of chain reaction in the forex market. One thing followed another.
Due to the Dollar demand from the FIIs, the Rupee touched its all time lows. The RBI came down heavily in response to this volatility in the forex markets and announced some real hard monetary measures on July 21st, 2000 to suck out excess liquidity from the market and to prevent bank speculation, when it increased CRR by 0.5%, bank rate by 1% and reduced the refinance facility provided to the banks by 50%. The very next day, the Rupee recovered by as much as 21 paise in a single day.
Another factor in the rupee fall is that it is largely driven by genuine importer demand and exporters preferring to retain their dollar receivables in their EEFC (Export Earnings in Foreign Currency) accounts abroad. Coupled with the RBI decision to stay away from the forex market intervention, the rupee went in for a free fall.
But these measures would have far reaching economic consequences. These were not short-term measures, and they would have their full impact in the long run, when all adjustments will be over. So the joy was very short lived and these measures proved detrimental for the economy as a whole. At a time, when most of the basic sectors of the economy had clocked single digit growth rates, this move of the Central Bank caused the interest rates to rise in the economy. Most of the major banks have already increased their PLRs. And the worst part is, the Rupee is still falling.
Rajneesh Mittal