The Indian economy has performed remarkably well in the past 10 years. Posting levels of growth only beaten by China. Admittedly the growth is not without problems (see: Problems of Indian Economy) in particular rural poverty and lack of infrastructure threaten to diminish the gains from growth. However, the strength of the Indian economy and its attractiveness for funds is causing a new and unexpected problem - a rising currency.
In 2007, the amount of global funds into India increased to a record $44 billion (up from $24 billion in 2006). India is an an attractive place for investment for several reasons:
- Emerging economy with much potential for further growth
- An alternative to the bloated stock markets of US and Europe (with concerns over the global credit crunch)
- An alternative to dollar based securities.
- Cheap labour makes it an attractive place for manufacturing and call centres.
Because of this the Indian Rupee has appreciated 15% against the dollar in the past year.
The future of the Indian Rupee depends on whether the government will want or be able to stem the flow of capital into India.
On the one hand capital flows are beneficial - providing funds for investment.
On the other hand if capital flows are not limited the rise in the Rupee may cause increasing hardship for exporters, especially in manufacturing and the financial services industry.
Another dilemna the Indian Federal reserve faces is between the exchange rate and inflation. Inflation in India is increasing as the economy reaches full capacity. To reduce inflation the standard response is to increase interest rates. However, increased interest rates will further strengthen the Rupee. Something the Indian Reserve bank will be reluctant to do.
The Rupee will also continue to benefit from the strength of commodities like Gold and jewellery. India is a net exporter of these.
It is likely foreign currency could continue to flow into India. however, in the long term inflationary pressures could start to weaken the Rupee, as it becomes less competitive on an international scale.
I feel the Indian stock market provides good potential for investment, but, the recent rises in the Rupee may be unsustainable in the medium term.