Call it the mother of all discounts. The price of one US dollar in May 2001 was Rs 49.06. On March 31, this year the dollar was selling at Rs 43.39. That is a discount of 13 per cent on the 2001 price of the world's most sought after currency. In the month of March alone the dollar fell against the rupee by over 4 per cent. The slow but steady rise of the rupee has left exporters panicky, policy watchers perplexed, consumers pleased and politicians proud-all at the same time.

But first the reasons behind the rupee's new found muscles. How is the currency that slid against the dollar all through its history-between 1991 and 2001 alone its value fell from Rs 18 for a dollar to Rs 49-now gaining in strength? In the past one year the rupee's rise has been the result of a global fall in the value of US dollar. That is, the dollar is falling against most global currencies and the rupee happens to be one of them. Many currencies have appreciated more against the dollar than the rupee has-the British pound 22 per cent, Indonesian rupiah 17 per cent and the Euro 40 per cent since 2001. There are a few exceptions and China is one of them. It has fixed the exchange rate of its currency at 8.28 yuan to a US dollar since 1996. When the rupee rises against the dollar, it also rises against the yuan (see charts).

The dollar's fall only added to the upward pressure on the rupee that had been building up due to acceleration of foreign-exchange inflows in recent years. In 2003 Indian forex reserves grew by an average of $100 million a day. While foreign investment (both portfolio and direct) was about $12 billion during the year, services exports (mainly software) and NRI deposits have been the other two big sources of dollar inflows. More than $30 billion were added to the foreign-exchange reserves in 2003 even though the Government repaid $5.3 billion of external debt during the year. Such a surfeit of dollars created demand-supply imbalance-the supply of dollars in India is more than its demand. And that is pulling down the price of the dollar to the rupee.

To prevent the rupee from appreciating the RBI has been doing what is called the "sterlisation" of dollars. It buys dollars from the market and issues rupees against them in the form of government securities. Given the huge influx of dollars, the RBI was running out of government securities to sterilise the inflows. It has proposed setting up a market stabilisation fund (a repository of government securities) which will be used to sterilise dollar inflows. But when the dollar started falling on its own, the central bank couldn't prevent the rupee from rising. "The RBI can influence the rupee behaviour, but it has no power over the movement of the dollar," says B. Bhattacharya, former dean, Indian Institute of Foreign Trade.

The rising rupee value has some macro economic benefits. It keeps a tab on inflation, directly by bringing down the prices of imported products and indirectly by putting pressure on domestic manufacturers to keep their prices low in the face of cheaper imports. Companies sourcing inputs in dollar and selling their products in the domestic market (e.g. mobile phones, personal computers) will benefit from rupee appreciation. But companies earning part of their revenues in dollars could see a fall in earnings. The government benefits from lower oil import bill.

The worst hit are exporters. A rupee appreciation raises the dollar price of Indian exports making them less competitive. Thankfully currencies of many competing countries too have appreciated against the dollar, reducing the threat of Indian exports losing out to cheaper substitutes from other countries. But the big worry is China which hasn't allowed its currency to rise against dollar and can price out Indian exports from some markets. So far though export growth has been buoyant despite the rising rupee. In 2002-3 Indian exports had grown by 17 per cent and in the first 10 months of 2003-4, by 13 per cent. Bhattacharya believes that the impact of a stronger rupee on exports will be felt after a lag. But he also feel Indian exports are becoming less price sensitive because of improved quality and branding.

Keen currency tracker and economist Surjit Bhalla is sure the rising rupee will hurt Indian competitiveness and growth eventually. Especially since Chinese yuan isn't appreciating. He recommends cutting customs duty rates and reducing interest rates to ease the upward pressure on the rupee. Lower duties will create demand for the dollar by increasing imports while reduced interest rates could stem the inflow of foreign investment in bank deposits. "Countries like Japan, South Korea and China have grown by keeping value of their currency low. India can't be an exception," says Bhalla.

Try telling that to some politicians who have been touting stronger rupee as a symbol of India's economic might. That's a fallacy. Growing foreign-currency reserves is a reflection of growing confidence in Indian economy, but rising rupee is not. Japan has forex reserves in excess of $650 billion and China has over $400 billion, compared to India's current kitty of $107 billion. But both the economic giants have not allowed their currencies to appreciate.

Even so, nobody expects the rupee to depreciate in 2004. In fact, most forecasts are of further appreciation in the rupee, although marginal. That is because the dollar isn't likely to rise soon. Neither is the growing foreign capital flow into India expected to subside in the coming months. So, for good or for not-so-good, the rupee will shine all through 2004.