Via email, V Anantha Nageswaran gave a simple theory on the USD/INR exchange rate. Posting it here with his permission.
Using the above chart, which charts the exchange rate over the last 20 years, he says:
The chart attached is quite clear. Except for the period between 2002-07 when actual growth and growth expectations in India shifted higher, the rupee has been on a trend depreciation.
Sustained high inflation (or, rather higher inflation relative to peers) caused by lack of fiscal discipline is the principal or predominant explanatory factor.
To bring back the experience of 2002-07, he states that we need to bring back sustainable growth rates of 7-8%.
Elsewhere, in The Hindu Business Line, S S Tarapore argues that the RBI should not intervene until the USD/INR is at 70. Quoting:
The RBI needs to accept that the rupee is still grossly overvalued despite the decline in recent days. It should not support the rupee till it reaches a rate of around $1 = Rs 70, which would be consistent with the long-term inflation rate differentials between the US and India.
My view is that this may not be enough – this view assumes that Indian businesses (specifically exporters) will be able to take advantage of the falling rupee and export more. This also assumes that domestic demand for petroleum products and gold (our two biggest imports) is elastic and will fall with the falling rupee. If these assumptions don’t come true, things are only going to get worse with a falling rupee.
Also coming back to Ananth’s point on the break in fall of USD-INR in 2002-07, I want to point out that despite our high growth rates in that period, we still didn’t run a current account surplus. It was just that our high growth attracted significant foreign investments which offset our CAD from that period to lead to a rising rupee. The consequent pulling out of those investments has hastened the fall of the rupee over the last few years.