"Even at present rates, the rupee is undervalued by some 25 per cent versus the dollar, on price parity" Mark Mobius, President, Templeton Emerging Mkts. Fund

Looking at Manbir Singh Bawa's trading room in a nondescript building in Colaba, South Mumbai, you'd never think the 30-year-old foreign exchange analyst at Mecklai Financial could have corporate India jostling for phone-time with him. But on February 5, 2003, that's exactly what happened. With the US Secretary of State, Colin Powell, expected to make his case on global television networks for a war against Iraq, the rupee-dollar rates were swinging madly. War was on every skittish corporate treasurer's mind. The result: The medium-built Bawa's phone just wouldn't stop ringing.

For almost nine months now-but more markedly beginning January this year-the rupee has been firming up on the dollar, sending exporters and chief financial officers (CFOs) of companies scurrying to forex analysts for an outlook every time a US offensive on Iraq seemed imminent. And on that day of February, the dollar looked much more vulnerable.

The volley of questions aimed at Bawa: Should we sell dollars now or wait for an hour or two? Will the rupee stay within the 47.72 to 47.77 range? Was the appreciating rupee just an aberration? What should we do? Bawa's advice to exporters on that particular day: Sell even if it's just a 10 paise gain.

To companies long used to a depreciating rupee-since 1990, the Indian currency has depreciated an average 4-5 per cent against the dollar every year-the sudden reversal in its fortunes means having to devise totally new strategies to manage their foreign exchange transactions.

Broadly, exporters-who, theoretically, become that much less competitive-now have to figure out how to make up not just for their more ''expensive'' goods, but also the fewer paises they will earn for every dollar. On the other hand, importers-whose purchases now become cheaper-have to take a view on whether the super rupee is here to stay. If yes, should they be hedging at all.

The point is, none of those questions can be answered without first understanding why the rupee is gaining on the greenback. Surprisingly, while opinion is divided on the why of it, there is consensus on one thing: that this is no flash in the pan.

The argument is seductive. After bottoming at Rs 49.06 vs the dollar on May 16, 2002, the rupee has steadily been inching up. By January 1, it had climbed to 48.03 and on February 7, it had gained another 33 paise. If one were to see it in percentage terms-which probably is the right way to do it-the rupee has gained 2.8 per cent between May 2002 and February 2003. In fact, analysts point out, for the first time since the forex market was deregulated beginning 1990, the rupee ended any calendar year (2002) with net appreciation.

Research analysts like Siddharth Mathur of J.P. Morgan think that's also because for the first time in that period India's current account-the value difference between what we export and import plus net invisibles-registered a surplus. This is an important indicator, because it reveals what's happening to business.

According to a Reserve Bank of India study, the major additions to India's foreign exchange reserves-up from $54.1 billion (Rs 2,59,680 crore) on April 1, 2002, to $72.4 billion (Rs 3,47,520 crore) by mid-January, 2003-have come from merchandise exports, software exports, and strong private remittances. The point: such inflow is not only here to stay, but there's no dollar outgo, because it comprises earnings, not debt.

That, in fact, strengthens the argument of economists like Arvind Virmani, a former economic advisor to the Ministry of Finance and currently Director of ICRIER, who contends that the rupee is gaining because India's reforms programme has been successful in one key area: external sector. He points out that India has not only lowered quantitative restrictions and tariff rates, but done well on exchange rate management, by letting market forces decide where the rupee should be. This, argues Virmani, has forced Indian companies to focus on their own efficiencies, with the result that they are much more competitive than they were, say, 15 years ago.

The economy, too, despite its missteps has been growing-at an annual average of 5.7 per cent for the last 23 years. Says Virmani: ''I don't see India breaking out of this Bharatiya rate of growth for the next couple of years, but nevertheless it is its underlying strength that is getting reflected in the current rupee rate.''

What about the war scare and the flagging American economy? Are they casting no shadow at all on the dollar and hence influencing the rupee's gains? Yes, they are, say some others. ''While we are bullish on rupee appreciating, a break-out of war is one of the key risks to our forecast,'' says Andrew Holland, Executive Vice President, DSP Merrill Lynch.

However, A.V. Rajwade, a Forex Consultant, points out that if one were to look at the real effective exchange rate (REER) index for the rupee, it has depreciated by about 3 per cent in the last one year. How? Simple. The other three currencies (Euro, Pound Sterling, and Yen) have gained much more against the dollar than the rupee has.

Therefore, in comparison, the rupee has actually depreciated-12.9 per cent against the Pound, 8.7 per cent against the Yen and 21.6 per cent against the Euro.

"An appreciating rupee helps us raise more money, since forward premium rates have become soft" Akhil Gupta, Joint Managing Director Bharti Tele-Ventures

Still, there's no dearth of people who believe that the rupee's gains are not only due, but long due. J. Mark Mobius, President of Templeton Emerging Markets Fund, has been predicting a rupee correction for the last two years. Even at these rates, Mobius feels, the rupee is undervalued by some 25 per cent versus the dollar, on price parity. ''But making such predictions over the short term can be quite dangerous because so many factors, including government efforts to influence rates, can intervene,'' says Mobius.

In fact, the Reserve Bank of India has been mopping up excess supply of dollars worth between $500 million and $1 billion a week (pouring in Rs 1,07,688 crore in the last one year) to keep the rupee from appreciating to a point where it hurts exports. But the bank's overall policy seems to be to let market forces determine exchange rates, and that signal has gone through to traders and industry. That's why experts are saying that the rupee's gain is not momentary, but reflective of economic fundamentals.

But what does the appreciating rupee mean for corporates, the economy and trade? Let's find out.

The Rupee
And The Corporates

A rupee going north is bad news for companies that earn in dollars. Take Wipro, for example. For every 1 per cent appreciation in the rupee, the software major's profit margins fall by 0.40 to 0.45 basis points. The solution? Taking forward cover on dollar receivables. At least for the next few quarters. And the fact that the forward premia at present is 3-4 per cent helps. Last quarter, Infosys was able to earn $1.5 million just by smart hedging. However, companies that earn in one of the other major currencies (Euro or Pound) will stand to gain, since the rupee has depreciated against them. This will also help partly offset the dollar losses.

Some companies like Tata Engineering are planning to repay part of their dollar loans ahead of deadline. The auto giant is repaying loans worth $75 million (Rs 360 crore), which not incidentally is equal to its net foreign exchange earnings last year. Taking the opposite route, Bharti Tele-Ventures is cashing in on softer international interest rates and raising money. It recently borrowed $315 million at an average cost of 5.5 per cent. Says Akhil Gupta, Joint Managing Director, Bharti: ''An appreciating rupee helps us raise more money, since forward premium rates have become soft.''

As for big importers such as Reliance Industries, the appreciating rupee could well be a bonanza (you pay fewer rupees for every dollar of import). At present, most of the net importers have chosen to keep the import cover open as it makes no sense to pay to hedge when the rupee is strengthening. Points out R. Shankar Raman, Vice President (Finance), Larsen & Toubro: ''We've stopped hedging payables, but have started hedging our dollar receivables.'' Like Larsen & Toubro, companies that are looking more at international markets and dollar earnings have to manage exchange risks actively.

The Rupee
And The Stockmarket

In theory, a stronger rupee means more dollar inflows because investors-especially those who have to show profits in dollars-are that much more confident of their dollar investment not depreciating. Therefore, foreign institutional investment should go up and along with it, the Bombay Stock Exchange Sensex.

In practice, it works most of the time. Consider a recent example. In May 2001, when the rupee was at Rs 46.92, the net inflow from foreign institutional ivestors was $265 million (Rs 1,272 crore) and the Sensex was hovering around 3,631 points. By June, the rupee was weaker at Rs 47, and the inflow of funds from foreign institutional investors (FIIs) had dropped to $135 million (Rs 648 crore) and the Sensex was quoting at 3,456. And so far in 2003, $309 million of net foreign money has flowed into the stockmarket, but the Sensex is even lower at 3,256 point.

What this shows is that a strong rupee alone isn't a big stockmarket influencer. Apart from market sentiment, most investors first look at the economic fundamentals-in India's case, continuation of the reforms programme-and then sector-wise opportunities in the country before making investment decisions. If at all, an appreciating rupee can only add fuel to the FII fund flow fire.

The Rupee
And The Economy

A strengthening rupee usually is bad news for exporters. However, this year, exports have continued to recover despite the rupee's northward run. Rating agency CRISIL's parameter of competitiveness (PARC) index measures the relative strength of Indian rupee versus its major competitors, mainly from the emerging economies whose exports compete with India.

The PARC index reveals that competitiveness between January and November 2002 declined by 52 per cent, meaning that the real value of the rupee increased by a similar amount. This was due to a nominal appreciation of the rupee against the dollar and price deflation among India's major competitors such as China.

According to CRISIL, the impact of declining competitiveness is likely to be felt on exports in the first half of 2003. If oil prices harden, imports will go up and widen the trade deficit, although software exports and private transfers could mitigate the pressures. Provided there's no dip.

As for the economy, with an appreciating rupee, inflation should go down. In January this year, inflation touched 4.42 per cent. Assuming that import invoices are in dollars, currency depreciation is instantaneous, there is no shift in trade patterns and global prices of imported commodities are not affected, and the rupee appreciates to Rs 46 to a dollar, a back-of-the-envelope calculation shows that the price index would go down by about half a per cent. That, in turn, will push inflation down to 3.9 per cent. However, should the rupee depreciate to 49 versus the dollar, the price index could rise by 0.25 per cent, pushing inflation up to 4.67 per cent.

But where do experts think the rupee is headed this year? Between 47.25 and 48 to the dollar, seems to be the verdict (See Betting On The Rupee). The key, however, to the question is held by Messrs Bush and Hussein. If there's a war, oil prices will shoot up, and an increase of one dollar per barrel will mean India has to cough up $550 million (Rs 2,640 crore) more. Besides, $4.2 billion (Rs 20,160 crore) worth of Resurgent India Bonds mature later this year. Although a sizeable chunk of the payments are likely to return to India by ways of non-resident Indian deposits, the potential capital outflow and concurrent higher inflation could weaken the current strong rupee sentiment. For the moment, though, the bets are on the rupee staying strong.