Between early May and early July, the rupee slid almost 15 per cent against the dollar, from about 53 to over 61. Any rapid change in prices—and an exchange rate is a price of a special kind—creates huge market disturbance, upsetting the calculations of those involved on either side of the transaction. In this case, economist pundits had long warned that the rupee was vulnerable—it traded at between Rs 52-54 per dollar for most of the preceding year—a stability that lulled many into assuming this would continue.
Prices arise from the interaction of demand and supply. Our demand for foreign exchange arises primarily from our import of goods, and the demand for rupees is generated when the rest of the world buys Indian goods (and services, but that is treated separately). India has always imported way more goods than it exports, and this gap is the primary source of our foreign exchange weakness. In the first two months of this fiscal, our trade deficit was $38 billion, for an annual rate of some $220 billion.
This massive...
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