Rupee's poll-time swings mysterious

Local currency has dipped before major elections and recovered just ahead of results for decades

R N Bhaskar | Mumbai

When the rupee began ceding ground to the dollar in the last week of last August, setting alarm bells ringing for exporters and economists, a money market dealer was overheard saying, "It (the local currency) will be weak till February, after which it will begin to recover." The nonchalance elicited titters, but the dealer remained unfazed, smug even. For many elections now, he had watched the currency wobble and felt this time would be no different. True to form, the rupee continued to tumble. At one point, the Reserve Bank of India even indicated it will not intervene to arrest the slide. The local currency kept falling and even breached 53 per dollar in January - an all-time low. Soon, election dates got announced and the rupee price began stabilising, just the way the dealer had said it would. The rupee closed Friday at 49 per dollar. Marketmen now believe it will continue to strengthen. While this may or may not be the case, it is worth looking at the way the rupee has behaved in the lead-up to major elections. The trend over the past three decades has been of a marked rise in volatility ahead of the election, barring only 2004. In fact, much of the volatility has become evident after 1980, when Indira Gandhi had already announced her bank nationalization and was about to announce her by-now-repugnant loan mela. But why do currency movements become more volatile just before elections? One theory is that a lot of foreign exchange comes into India - politicians are believed to bring in this money to meet poll expenses. But then, this should help the rupee strengthen, not get weaker. So, could someone be ordering a tweaking of the rupee-dollar rate? A second theory is that foreign direct investment flow begins to taper before the elections, perhaps because of economic uncertainty. That such a brief disruption of inflows could have caused the rupee's weakness is, however, hard to believe. Also, this theory does not explain why the rupee strengthens just before the results are declared. Normally, it should have strengthened after the results. A third theory believes the weakening of the rupee is on account of foreign institutional investors (FIIs) taking away their money. Some say much of the FII money could belong to Indian entities, which have clandestinely hoarded money overseas -- CBI's estimate, in fact, is that it could be over $500 billion. Was it because they too were becoming jittery? That isn't clear. But this theory also does not explain why the rupee strengthens even before the election results are announced. Obviously, the RBI needs to study the phenomenon more closely than it has up till now.