The Reserve Bank of India, which oversees the rupee-dollar exchange rate, is allowing the rupee to appreciate. It has the approval of the government because in a Cabinet note on prices, the finance ministry has said a combination of rupee appreciation along with tightening monetary policies would be the best solution for tackling inflation.

The rupee has been strengthening against the dollar over the last couple of months. It touched a nine-year high of 41.57/58 against the dollar a few days back. Although this seems to be a short-term view of the government, speculation is now rife that the rupee might be allowed to breach the 40 per dollar mark or even higher.

An appreciation of the currency helps increase the supply of goods and services domestically by making imports cheaper and exports expensive. This, in turn, helps to control inflation. A rising rupee has a dampening effect on exports since they become more expensive in dollar terms while imports become cheaper.

However, the negative impact on exports is immediate. India's Federation of Indian Export Organisations (FIEO) says the appreciation of the rupee has severely eroded the profitability of exporters. For IT exporters the rising rupee could mean a fall in operating margins and increased costs as they will receive less rupees for each dollar earned. According to Ambit Capital, each percentage rise in the rupee shaves off 30 to 40 basis points from an IT company's margins.

Those in textile business face stiff competition from our two neighbours Bangladesh and China. Bangladesh's exports to the US increased by six per cent while ours declined by 12 per cent, despite a much larger production capacity. Chinese exports rose by an even higher 23 per cent. With the rise in rupee India's textile will become more expensive than those manufactured by our counterparts. The Southern India Mills Association (SIMA) appealed to the Centre to immediately control the rupee appreciation against the US dollar to sustain the export growth of the Indian textile and clothing industry and have a level-playing field in the global market.

BPOs could be the worst hit as the margins earned by the foreign companies from outsourcing jobs to India are coming under pressure. The ITeS sector is less likely post higher growth rates as it has done in the past.

Even the India Inc. is divided whether the Reserve Bank should take steps to protect exporters from the appreciating rupee that will adversely affect their profits. While leading business chamber CII says the domestic industry would have to accept a strengthening rupee in the short term, FICCI, Assocham and exporters' body FIEO want RBI to intervene and check the sharp rise in the currency.

The argument of controlling inflation through a stronger exchange rate works in theory which states that imports increase the supply of goods, and cheaper imported goods help control the cost of the typical consumption basket. This works fine in a country like the US, where everything from coffee to footwear and clothing is imported. But look closely at India's import basket. The largest components comprising our import baskets are crude oil and electrical and non-electrical machinery, that is, capital goods. The latter does not have much impact on inflation but the former does. But these are de facto administered prices. Besides petrol prices can be tweaked without reference to the exchange rate, simply by reducing duties, or asking oil companies to hold prices and reimbursing them from the tax kitty. This fiscal response is independent of rupee-dollar relation.

The rise of the rupee against the dollar is without precedent, and seems to have been determined by volatile flows, not by macro-fundamentals. In the absence of hedging instruments like currency futures it seems pernicious to let the rupee rise abruptly, all in the name of inflation control. India has close to 12 million small and medium enterprises. They contribute around 6.7 per cent to the GDP and employ 30 million people, second to agriculture. They comprise 35 per cent of the total exports.

It is important to remember that in India exports create employment. One can expect that all those sectors that have been adversely affected due to this appreciation of rupee will withhold their expansion plans and capital investment. This would translate into less employment opportunities, badly impacting job seekers. So, at the end of the day the government might be able to tame inflation but will have unemployment and diminishing growth rate as its policy by-products. All these are bad signals for our economy, which is one of the fastest growing nations in the world now.