The Indian rupee has witnessed considerable volatility since the beginning of this fiscal. The repatriation of Indian Millennium Deposits early this year put considerable pressure on the rupee liquidity. The rising LIBOR rate, compelled with a falling dollar, have put exporters in a dilemma whether to go for PCFC or rupee loan.

The rupee had appreciated from its historic low levels of 49.06 in May 2002 to the 43.10 levels on July 21, 2005, on the day China revalued its currency. The appreciating mode was exemplified by the weakness in dollar against major currencies. The US interest rates were at historic lows as the FED tried to save the US economy from the threat of deflation post the dotcom bubble burst and the 9/11 debacle. Thus the resultant low US dollar interest rates prompted Indian exporters to go for foreign currency loans (popularly known as PCFC) for their working capital. There were two advantages in availing this loan; one is with regard to low interest rates; the other is, by availing PCFC for working capital, the dollar/rupee risk was nullified, as this was tantamount to selling dollar for rupee in the market (also they were allowed to take PCFC on forward contract entered for hedging export receivables). On an average the rupee kept appreciating by about 3% per year and the net interest cost to the exports turned negative.

By early this year things began to change. The repatriation of Indian Millennium Deposits had put huge pressure on rupee liquidity as about seven billion rupee equivalent had gone out of the market. Since the RBI was very cautious of the high oil prices and spiraling asset prices it was not in a position to cut the operational rates like the Cash Reserve Ratio (CRR) and the Repo Rates to provide liquidity support as that would have signaled a dovish stance. Thus the tightness in liquidity made forward premiums to shoot up and the one year forward premiums touched a high of 105 paisa by March. This left the RBI with no option but to intervene in the forex markets to buy dollars to provide equivalent rupee liquidity. This had the added effect of correcting the Real Effective Exchange Rate (REER) which apparently made the rupee look overvalued.

Treasury Management Magazine, US Economy, Cash Reserve Ratio, CRR, Real Effective Exchange Rate, REER, Reserve Bank of India, RBI, Forex Markets, Indian Millennium Deposits, Foreign Currency, Indian Exporters, Asset Prices.