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Exchange controls in sight?

T.B. Kapali

IT appears direct exchange control measures may soon become necessary to arrest or slow down the pace of the rupee's fall.

A higher surcharge on import finance or even high cash margins for opening of LCs - reminiscent of 1990 and 1991 - could indeed become necessary as the Reserve Bank of India's interest rate measures (intended to operate through the inter-bank market) do not seem like providing the rupee enough of protection. Stringent moves on the receivables side also may have to be contemplated to expedite the inflow of foreign exchange into the domestic markets.

The underlying problem appears to be one of substantial (dollar) demand/supply imbalance in the general merchant segment. And, interest rate measures intended to increase dollar supplies in the inter-bank market may not really prove helpful. Direct cont rol and elimination of excess foreign exchange demand then becomes necessary and this would take the system back to a regime of exchange control measures.

The larger issue here is regarding the efficacy or otherwise of the monetary policy transmission mechanism. The tight money signals being sent by the RBI do not seem to be permeating the banking system and the general interest rates structure as quickly or in the manner (in terms of magnitude) the RBI would want it to.

The large overhang of liquidity in the system - with considerable amounts of coupon inflows and redemptions of securities holdings coming through - obviously is mitigating the impact of the RBI's dear money measures. Interest rates in the general market - say for import finance - therefore have not risen enough to curb import demand itself.

The RBI either has to resort to stronger doses of monetary tightening -- meaning a further hike in the CRR, Bank Rate and its repo rates - and wait for its impact to work through the general structure of interest rates.

Or consider exchange control measures which can physically and immediately contain import demand. Here too, not much of relief may be available as the demand pressure in the market seems to be emanating more from the capital account than from the current account. Non-oil imports have risen only 10 per cent in the first quarter of this fiscal from previous year levels.