Ever since the beginning of 2003, Indian Rupee (INR) has been showing signs of appreciation vis-à-vis the US dollar. Though the initial reaction to the appreciation was termed as a temporary phenomenon, the persistent appreciation of the INR during the last six months reveals a different story. Throughout the last decade, INR had been depreciating. In March 2001, dollar was at Rs. 26.40 and on May 2002, rupee reached the bottom at Rs. 49.08 to a dollar.

Owing to the fundamentals of the Indian economy and the bleak economic outlook for the US economy, INR has been appreciating steadily against the dollar. As a result of the positive aspects of the Indian economy outweighing the negative aspects burgeoning foreign currency reserves, a steady pick-up in industrial growth, further liberalization of Indian economy and encouraging climate for investments, are acting behind the scenes. And for the first time in 25 years, the current account balance of payments is surplus. This transformation in the Indian economy is reflected in the appreciation of the rupee. On the other, the backdrop of a weak economic outlook and soft interest rates, dollar has been depreciating against all other major currencies. In fact, this reversal of trend has prompted many economists to conclude that dollar is losing its strong hold on the global economy.

There are a number of factors that have influenced the appreciation of the rupee. In a floating exchange rate system, the movement in rupee-dollar exchange rate would reflect the demand-supply situation for US dollar against Indian rupee. So, the recent appreciation of rupee against US dollar is to be primarily explained by the supply of dollar exceeding its demand in the Indian foreign currency market. This is due to the current account surplus in India's balance of payments (the first time in 25 years), helped mainly by remittances from Indians abroad and export of services, particularly software exports. In addition, there has been a steady flow of foreign capital from abroad. The capital inflow has received a big boost, as the interest rate in India is 4 to 5% more than the interest rate in USA. In fact, rupee would have appreciated even more if the RBI had not created a demand for dollar by buying up dollars from the market and adding to its foreign exchange reserves.

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