The RBI has to keep in mind not only what is happening to the US exchange and interest rates, but also the changes in the REER, relative productivity and what competitors such as China are doing.

The immediate cause for the appreciation of the rupee is the weakness in the dollar. But the latter has declined much more against the euro, which is a pure float, while its decline against the rupee is a managed float. Therefore, the changes occurred partly because the Reserve Bank of India (RBI) allowed them to. It is continuing to buy dollars even as reserves exceed 130 billion to moderate appreciation, using the enhanced monetary stabilization scheme to sterilize and prevent over expansion in money supply.

The following table gives a picture of the recent changes in the Indian nominal rupee dollar exchange rate. The overall appreciation against the dollar this year is about 3%, and so long as it remains marginal; and the RBI has the weapons to keep it so; it will not affect trade. But, the dollar decline is an opportunity to deepen forex markets in India. After depreciating steadily through the 1990s, the rupee is now showing interesting variations. There has been an annual appreciation since 2002, but in that year there was little variation.

This was the typical pattern when volatility was low in the 1990s. In that decade the nominal exchange rate was held rigid as the RBI kept buying the dollars that were flowing in. It intervened heavily in the market to quell periods of externally induced high volatility, often raising short-term interest rates sharply. The forex markets over-reacted to shocks. Sustained one-way movement encourages market players to bet on that movement and enhance it further.

RBI, US exchange, interest rates, REER, relative productivity, competitors, China, euro, managed float, Reserve Bank of India, moderate appreciation, monetary stabilization scheme, money supply, marginal, weapons, trade, dollar decline, forex markets, annual appreciation, volatility flowing in, quell periods, over-reacted, one-way movement, market players.