New Delhi/Chennai/Hyderabad: The rupee hit a nine-year high of Rs39.875 against the US dollar on Thursday, breaching a psychological barrier of Rs40, fuelling government concerns about India’s continued ability to export and the potential to hurt key sunrise sectors, such as technology services.

So far this year, the rupee has gained 9.7% against the dollar, rising a hefty 67 paise in just the past three days after Thursday’s 32 paise rise. The last time the rupee was under Rs40 was on 13 May 1998, when it had ended at Rs39.85 to a dollar.

The Reserve Bank of India building in New Delhi

The interest rate differential between Indian rates and those prevailing in the US, of around 300 basis points, is also providing an arbitrage opportunity, triggering a further step-up in foreign inflows.

“This is a new situation and needs a new response," said commerce minister Kamal Nath. “Export is the engine of growth and we have to ensure that growth is not affected. We are going to look at it immediately."

Nath had previously indicated that the $160 billion (Rs6.4 trillion) export target for the current fiscal may have to be scaled down.

Despite the Sensex’s rise, shares of sofware and tech services exporting companies fell as investors bailed out of companies such as Tata Consultancy Services Ltd, Infosys Technologies Ltd and Wipro Technologies Ltd.

Exporters have already been complaining that the rising rupee was eroding their margins, especially in some traditional services such as gems and jewellery and textiles, as well as new growth segments such as software services.

“It does impact our margins. It will be felt in the subsequent quarters," said R. Rajesh Ramaiah, corporate treasurer for Wipro, India’s third largest information technology firm by revenue. According to him, Wipro had covered for fluctuations of the rupee against the dollar, the currency it bills many of its customers in, for the second quarter to September, but would see margins affected with the Indian currency dropping below Rs40.

Indraneel Ganguli, vice-president, global marketing and communications, Satyam Computer Services Ltd, said the rupee appreciation would not have a significant impact on the company’s financials since it has been efficiently hedging its dollar earnings.

Habil Khorakiwala, president of the Federation of Indian Chambers of Commerce and Industry (Ficci), said in a statement that ground-level feedback collected by Ficci from exporters showed a weaker order-book position of several exporters compared to six months ago. As a result, the export performance in the next six months would be affected. In dollar terms, export growth is lower at 18.2% in April-July, the first four months of the current fiscal, while in rupee terms, the growth is less than 6%.

The textile industry, which operates on much smaller margins, is fearing the worst.

Harish Cherukuri, managing director, Priyadarshini Spinning Ltd, said the appreciating rupee was eroding India’s competitive edge against companies located in China and Bangladesh.

“The rupee appreciation has affected our margins adversely. We are not able to get new businesses and are only servicing existing orders", said Britto M. Joseph, managing director of JVS Group, whose clients include the world’s largest retailer, Wal-Mart Stores Inc.

JVS Group’s revenue for the current year ending March were likely to remain flat at Rs200 crore, compared to the ambitious target of Rs300 crore set earlier.

Kanhaiya Singh, principal economist, National Council of Applied Economic Research, an independent think tank in New Delhi, said, “We have always maintained that the interest rate hikes have been too strong. A low-interest regime benefits even the corporate sector."

The Reserve Bank of India (RBI) has increased its repurchase rate to a five-year high of 7.75% by raising it six times since 2006. The US Fed’s latest cut, the first time in four years, brings its benchmark rate to 4.75%.

The spread, or the yield difference, between a 10-year US Treasury note and a similar-maturity Indian government bond has widened to 3.29 percentage points from 2.77 percentage points on 18 July, Bloomberg data show.

Analysts also say that with Indian inflation at 3.5%, far lower than RBI’s comfort mark of 4%, there would be pressure from industry lobbies to cut interest rates.

“It is high time that interest rates move down, because there are sure signs of a real sector slowdown," says Ashima Goyal, professor, Indira Gandhi Insititute of Development Research. “In the absence of that, it would be impossible to hold back the surge of capital that’s trying to gain from the arbitrage opportunties between the US and Indian interest rates, unless the government wants to try really strict capital controls."

An appreciating rupee only makes it more attractive, especially for hedge funds, to engage in interest rate arbitrage. This, if not checked, argue economists, can become a self- perpetuating cycle, as more funds will flow in and put additional pressure on the rupee to appreciate.

According to RBI, in the eight months ended August, foreign funds have bought a net $9.4 billion of stocks. In 2006-07, foreign direct investment (FDI) more than doubled to $21.2 billion, compared with $15.6 billion of portfolio investments. Consequently, foreign currency reserves were up by around $47 billion in the last fiscal.

The government projects $30 billion FDI this fiscal year. Apart from this, Indian companies have been borrowing heavily from overseas, and external commercial borrowings accounted for 56% of India’s foreign debt last fiscal.

The rupee’s gain also gives a much-needed respite to the Central government, which has not raised petrol and petroleum products prices since last year even as crude is touching $80 a barrel. To mitigate costs, the government issues bonds to oil companies to cover part of the losses. The companies then offload these bonds, which are underwritten by the Centre, and recover the monies. In 2006-07, they issued Rs17,262 crore worth of bonds. However, Goyal said “over time, the government’s liabilities even out because, just as it is slow in raising domestic prices when Brent crude goes up, it is equally tardy in bringing them down when Brent falls."

Bloomberg and PTI contributed to this story.