BOMBAY, 25 November 2002 — Be it a resident of India or a non-resident Indian (NRI), the million dollar question gnawing at everyone’s mind is — where is the Indian rupee vis-a-vis the US dollar headed? Over the past few months, the Indian rupee has been appreciating against the US dollar. In the first six months of the current fiscal, the currency had depreciated to 49.05 levels as on June 2002, after which it has been staging a quiet recovery.

The rupee scaled a 12-month peak closing at 48.1975 per dollar on Nov. 16 on the back of international rating agency Moody’s announcing a review of the India’s foreign currency ceiling for debt. This is closest to the level the rupee was on Dec. 27, 2001, when it was trading at 48.20 to the dollar. Infact Moody’s observations were a shot in the arm for the rupee which since then has been gaining strength.

The Reserve Bank of India (RBI), in fact, sees the rupee undervalued to the tune of 3-3.5 percent compared with the five-country trade weighted real effective exchange rate (Reer). The point to note is that although undervaluation of the rupee has happened in the past, it used to be a result of weakness of the greenback. Today, with higher share of euro in Indian trade weighted basket, pressure on the Indian unit to appreciate is high. If the inflation continues to be low, the rupee undervaluation is likely to stay in long run. Certainly, the RBI’s wisdom in not allowing capital account convertibility will go a long way in keeping the rupee rock steady and preventing a repeat of Indonesia in India.

Forex analysts contend that the rupee is on an uptrend and is likely to strengthen to 48.00 in its current rally. However, analysts say, RBI is facing a lot of pressure from exporter lobbies, especially from the software sector, to let the rupee depreciate, as the strengthening of the currency has impacted their earnings significantly this year, as bulk of their revenues is in US dollars.

For instance, Infosys’ management admitted that the dollar depreciation resulted in a gross negative impact of Rs.36.4 million against the handsome forex gains of Rs.65 million reported in the first quarter of this fiscal.

Among the top-rung companies, the risk to Satyam’s earnings is the highest because over 90 percent of its cash is parked in US dollar deposits. Even Infosys with only about 20.3 percent of cash in foreign currency deposits, it had to make translation adjustment of about Rs.10 million in the last quarter. So what’s the way out for the domestic software companies? Economists believe the most strongest defense against the strong rupee is globalization of production and development centers in case of software companies.

And talking about reserves, India’s foreign exchange reserves have crossed $65 billion, bolstering an already comfortable looking external sector. Over the past 11 months, the RBI has added in excess of $17 billion to its reservoir. It stood at $48.045 billion for the week ended Dec. 28, 2001. Forex analysts attribute the rise to substantial NRI remittances and heavy foreign direct investment (FDI) flows. Large FDI flows were reported this year into pharma, telecom, energy and infrastructure sectors.

Were it not for RBI absorbing these flows, the rupee would have appreciated much more. The inflows are being driven by two new factors.

First, the current account has turned surplus from last year after a gap of 24 years. And secondly, the forward premiums (at 4 percent levels) are significantly higher than what most banks and corporates expect the spot to depreciate, leading to significant shifts in the hedge ratios.