RBI Governor YV Reddys sphinx-like remarks (sample: the day before yesterdays volatility is todays flexibility) hardly indicate the likely direction of policy. He has also consistently refuted any suggestion that the RBI targets any particular exchange rate of the rupee: Over the last four years, the exchange rate has moved in both directions and that shows intervention was not there at any particular rate. He added that, As far as our exchange rate policy is concerned, it will be the same and will continue to be so.
Dr C Rangarajan, former RBI Governor and chairman of the council of economic advisors, has provided a valuable clue in this regard. According to him, there were several concerns: The rupee can be allowed to appreciate, provided all other currencies are doing so. Our immediate concern is China; and the renminbi is not going up, so our hands are tied. This is the clearest indication that the rupees rise will not be unfettered, considering its competitiveness vis--vis the Chinese unit. How valid is such a concern On the face of it, it certainly appears valid, as the yuan has risen less against the dollar than has the Indian rupee this year. For all the talk of China allowing a wider band for the yuan to fluctuate versus the dollar, it has appreciated by only 1.2% while the rupee has gone up against the dollar by 8% between January and May 2007. The rupee has thus strengthened against the yuanwhich might be more pronounced if one takes into account higher inflation in India than China. The eroding competitiveness of the rupee relative to the yuan is bound to affect Indias export prospects in areas like textiles where China is a direct rival.
The flipside, however, is that India s exports have steadily diversified in the direction of greater value addition and superior quality; as a result, they have become less sensitive to exchange rate movements. So long as Indias exporters keep lowering costs and upgrading quality, the rupee rising need not prevent them from taking on China.