If the RBI was aggressive enough, levels above 42 did not seem impossible. Our line of reasoning was simple - oil prices have been moving up and export growth is patchy, pushing the trade deficit wider.

After a period of strong FII inflows chasing both a string of Indian IPOs and secondary market stocks, sheer investment fatigue would entail a moderation in investment flows.

Risk appetite has weakened on the back of the sub-prime crisis and would add to the apathy of fund managers towards Indian equities, whose valuations looked a trifle stretched in any case.

Regulatory changes such as the curb on the end-use of external borrowings as well as the rising cost of foreign loans would turn off the spigot of foreign currency debt. Thus the demand for dollars would outstrip supply, at least for a couple of months.

The RBI seemed uncomfortable with the degree of appreciation and would take advantage of any temporary dollar shortage to push the rupee down further. In short, the case for a weaker rupee seemed watertight.

The fact that contrary to our expectations the rupee is currently trading below 41.50 and the pressure to appreciate further hasn't quite abated tells us a number of things. For one, it underscores the point that there is much more to the balance of payments than the trade deficit and portfolio investments.

Our forecasts for the currency are often somewhat irrationally guided by the data on these two components, simply because high-frequency data are available for them. Data on other flows are available only at discrete intervals - that however does not make them any less important in determining the exchange rate.

At the moment, two such "black box" flows seem to help the rupee appreciate. There appears to be a full pipeline of private equity and foreign direct investment flows keeping the appetite for the rupee strong.

If the surge in private equity flows that is being reported anecdotally is indeed true, then it certainly is an interesting development. One hypothesis is that Indian companies are circumventing the curbs on external commercial borrowings by raising more funds through this route. Whatever the reason, the appetite for Indian private equity offerings seems somewhat undiminished, despite the enhanced perceptions of risk. In fact that applies to equities in general. Instead of displaying signs of fatigue, fund managers appear to be increasing the allocations to the equity markets.

The grapevine has it that the FII portion of last week's Power Grid Corporation (PGC) IPO was oversubscribed over a hundred times. Flows into the secondary market may not be as spectacular as in July but have been reasonably healthy.

The current trend in Indian (and other Asian) equity markets against the backdrop of a relentless flow of adverse news on the US economy and mortgage markets suggests that investors perceive some degree of "decoupling" between Asia and the G-7 economies. Thus, they (investors) seem to anticipate that Asian growth, particularly in countries like India and Indonesia that have large domestic markets, will hold up even if US growth were to slow sharply. These markets could thus emerge as a "safe haven" that investors might flock to if global risks multiplied further.

There are some insights into the RBI's strategy of exchange rate management that the rupee's behaviour over the last month offers. For one, by imposing the restrictions on ECBs, it clearly indicated that it was uncomfortable with both the level of the rupee and the continuous appreciation. However, its intervention in the currency markets has remained somewhat "passive".

Thus, while it bought dollars to arrest the momentum of the currency, it did not really make an attempt to actively depreciate the rupee. Let me make myself clearer - there was a phase in the second fortnight of August when the rupee had slipped quite a bit. It had, from what I remember touched the 41.70 levels for a few hours.

This was a period when markets were waking up to the fact that the fallout of the sub-prime problem would be worse than anticipated. The RBI could have taken advantage and pushed the rupee up further against by continuing to buy dollars. It chose not to do this and the rupee moved back up. Some market players view this as a lost opportunity.

Where is the rupee headed in the medium term? It doesn't quite take rocket science to figure out that if flows were to follow this pattern and the central bank were to follow its current strategy, we are in for more appreciation. There could be brief spells where there are bunched-up outflows (when the rupee could soften but this is likely to be transitory). Exporters and importers could perhaps work with the assumption that a tightly ranged rupee between, say, 40 and 41 to the dollar is likely to be the norm going ahead.

Depreciation beyond this range would be possible only if the global risk appetite suddenly worsens so sharply that equities as an asset class get the short shrift. Alternatively, if some of the domestic macro numbers (like the industrial production index) were to shake the faith in India's secular growth prospects, inflows could weaken. Finally, more aggressive central bank action where the RBI picks on any temporary mismatches of flows to weaken the rupee further could perhaps do the trick.

The author is chief economist, HDFC Bank [Get Quote]. The views here are personal.