India is facing a peculiar problem of ‘Dutch Disease’. The term refers to a situation where there are large inflows of foreign exchange due to discovery of natural resources or massive foreign investment in the country which in turn leads to appreciation of the currency, undermining the traditional export industries. (This term originated from the adverse impact on Netherlands due to the discovery of natural-gas deposits).

The Indian rupee has appreciated by nearly 10% since late 2006 suggesting the country’s attractiveness to foreign investors and optimism about the Indian economy. Apart from US dollar, the rupee has also appreciated against other currencies. During the first half of 2006, rupee has appreciated in terms of pounds, euros and yen by 8%, 6.9% and 11.2%, respectively.

Why did the rupee appreciate?

  1. Growing domestic market and an attractive export base, leading to increased FDI.
  2. To finance investment and acquisitions abroad, Indian companies borrowed money overseas which returned back to India boosting capital inflows.
  3. Foreign portfolio inflows in the booming stock market.
  4. Investments and remittances by Indian settled abroad owing to attractive interest rates in India.

But the main issue is how to deal with the export downturn due to rising prices of Indian products in overseas markets thus reducing competitiveness. On the other hand are the cheaper imports which also aids in reducing inflation. The RBI has made a move in this regard but is it enough is the big unanswered question.