Ajay Shah Column FE

There is a lot of focus in India on the rupee dollar rate and on RBI’s foreign exchange reserves, as measured in dollars. However, the dollar is not a stable yardstick. The dollar has itself been fluctuating quite a bit. We should be careful not to read too much in changes in the rupee-dollar rate or in the level of reserves which merely reflect fluctuations of the dollar.
Figure 1 shows the familiar history of the rupee-dollar rate. It runs from April 2006 till the end of October 2008. This shows a depreciation of the rupee from roughly 40 to the dollar in early 2008, first to 42 and then a much sharper movement to 50 rupees a dollar. What was going on?
Many people think that in the global financial crisis, FII and other capital left the country, thus giving a sharp depreciation. This picture is mostly wrong. In order to get a better sense of what is going on, we turn to the ‘Major Currencies Index’ maintained by the US Federal Reserve (Figure 2). This is an index of the movements of the US dollar against the major floating exchange rates of the world. This index, which is abbreviated “USM”, shows a gradual dollar depreciation from the index level of 85 to 70 through 2007. In recent months, it shows a sharp appreciation of the dollar. The entire dollar depreciation of recent years has been reversed in a few weeks.