How much should one read into the rupee weakening vis-à-vis the dollar? Arguably, with India’s macro fundamentals and high growth rates, as a long-term trend, the rupee should appreciate against the dollar in real terms. But there are several caveats to this proposition. First, the present forex market is a narrow one, and any sudden and transient mismatch between supply and demand causes fluctuations around the underlying trend. Second, inflation rates in India have inched up. Indeed, inflation judged by any of the consumer price indices is already close to 7 per cent. This suggests rupee depreciation against trading partner currencies, not just the US dollar. Third, there may often be contradictory pressures to this principle operating through the capital account. Not only does India no longer have a capital account surplus, but the current account deficit is also larger because of greater non-oil import demand and higher prices of crude.

Add to that liberalization of the capital account and outflows of foreign direct investment from India exceeding inflows into the country this calendar year. While there are expectations of interest rates hardening in India, those fears are not immediate. Despite returns to capital being high in India, foreign institutional investors are probably not pushing in large doses of new money, and this is linked to the fourth point about expectations, which influence short-term trends, in a significant way. Here, inflation is a serious worry. Fifth, it is a figment of the imagination that the exchange rate is completely market-determined, since it is subject to intervention by the Reserve Bank of India, and one suspects that the RBI is happy to see the rupee slide a bit. Ipso facto, there is no particular reason to read anything more than transitory effects into the rupee slide. Nor is there any reason to question India’s macro fundamentals. Rupee depreciation reduces pressures for protectionism and enables one to reduce tariffs, without adverse effects on customs revenue.