Trillion dollar question: How to tackle rising Re

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: A nine-year high rupee has helped make India a trillion-dollar economy, said a recent Credit Suisse report. But reaching the trillion-dollar mark riding primarily on rupee appreciation has its own perils and may not be enough to sustain it unless supported by the real economy.

The story of the rupee rise against the dollar may have many sub-stories but just one conclusion: it’s time to take the issue of capital account convertibility more seriously than ever if India wants to be a $10 trillion economy by 2025.

It was in 1995 that the rupee was de-linked from a fixed peg and was allowed to be determined by market forces up to some extent. Allowing market forces to determine the rupee exchange rate against the dollar could see the rupee weakening and might create a political problem of being labeled a weak nation.

At the same time, it is widely acknowledged that making the nation look strong through a stronger rupee will hurt exports badly (reflected in the current situation) and will not allow Indian goods a competitive pricing in the international market. The Chinese have mastered this art. And despite formidable pressures from the US and Europe the authorities have kept the yuan undervalued to gain export advantages. But then China is not a democracy and there could be further debates on their policies. Though the rupee exchange rate is largely considered to have been determined by market forces, necessary RBI intervention at the time of both appreciation and depreciation, has positioned the Indian currency between 43 and 45 for over a decade. As a matter of fact, over a decade, this has been the central bank’s tactic in forex management, ably supported by political authorities.

Given the overall situation in terms of huge capital inflow, priorities of policy-makers seem to be changing very fast. The latest explanation, to allow the rupee to rise at the cost of export competitiveness, is that it has been done to contain inflation.

Basically, the fact that the RBI is no longer sterilising the dollar through rupee injection aggressively to check the money circulation is creating more dollars in the system and thereby depreciating its value. The RBI is targeting money circulation at around 17.0-17.5% in 2007-08 from over 20% in 2006-07.