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RBI: Trying to steer clear of anachronisms?

T.B. Kapali

IT is well known that the initiation of economic reforms in India (at the turn of the last decade) was not fully out of conviction and by choice. Indeed, it was the major balance of payments (BoP) crisis in 1990 which triggered off and compelled the move towards large-scale economic liberalisation.

Of course, those at the helm of policy-making at that time also capitalised, to some extent, on the space and leeway which the BoP crisis seemed to create for reform measures - measures which in an earlier era would have been considered sacrilege and bl asphemy of the highest order.

That is, while the initial momentum towards and compulsion for reforms was provided by the crisis, policy-making at least got convinced enough to sail with the wind as far as possible.

It is such an ability to sail with the wind (and capitalise on the opportunity for institutional reforms) which could stand the Reserve Bank of India in good stead as it grapples with the latest bout of volatility in the local currency markets.

While still not a crisis comparable in magnitude to that in 1990, the latest bout of rupee weakness would still seem to point to the scope for (and indeed even the need for) the RBI to be liberalised from the shackles which an outdated policy regime and institutional arrangement imposes on the central bank.

Under the outdated policy regime and institutional arrangement, the central bank is responsible for the value of the domestic currency's exchange rate, even as wholesale changes are coming about in the nature of the Indian economy's interface with the ou tside world.

Indeed, in an environment marked by full capital convertibility rights (at least for non-residents) and rapidly disintegrating current account controls, it appears anachronistic for the central bank to be held responsible for order and stability in the currency markets. That is, while the foundation and superstructure which could help the central bank dictate and decide the external value of the currency crumbles, it (the central bank) continues to be held responsible for the attainment of goals which may not strictly be feasible in the current era.

A silver lining in the horizon, though, is that the Reserve Bank itself seems to have begun articulating, albeit in a very indirect manner and in fairly soft language, the contradictions inherent in the present arrangement.

The burden and baggage from the past though still seem to be heavy. And that is what results in the central bank taking recourse to measures such as interest rate hikes to defend a currency being pulled down by pure fundamental factors. The broader econo my then pays the price - in terms of firmer interest rates and a deceptive stability in the currency which hurts import-competing industries and the overall trade account also.

A study of the central bank's reactions and responses to the movements in the dollar/rupee market over the past 3 months brings out this aspect of RBI policy -- a desire to sail with the wind (rationalising the rupee's downmoves) at one point even as the historical baggage element manifests itself in interest rate moves in currency defence at some other point in time.

Both in its May 25 and August 3 statements, the RBI has gone to great lengths to justify and rationalise the fall of the rupee. This has been done by bringing in the concept of ``effective exchange rates'' - a number which indicates what, on average, is the rupee's level against a basket of currencies. The focus is not on the bilateral dollar/rupee rate but on where, on the average, the rupee stands vis-a-vis a group of currencies with whose countries India conducts most of her trade.

Therefore, even as the rupee has fallen by around 5 per cent in the recent past - from around 43.50 late April to around 45.80 currently - it continues to rule steady against the other major international currencies since the US dollar has appreciated ev en more against the other currencies or has undergone a correction which only preserves its competitiveness. The dollar is up 4.5 per cent against the sterling in the same period and also up by around 2/3 per cent against the euro and the yen.