Exchange intervention - an uneasy option

By S. Swaminathan

Dr. Bimal Jalan, Governor of the Reserve Bank of India, is rarely given to elaborate articulation of monetary policy, its options and compulsions in the Indian context. His observations on Thursday, on the occasion of the Eleventh C. D. Deshmukh memorial lecture in Mumbai on the complexity involved in guiding monetary policy in countries such as India towards a plurality of objectives through a multiplicity of instruments and the implications for intervention in the forex market assume added significance on that score.

Given the fact that the rupee has depreciated by about 7.2 per cent by the end of November as against the dollar (at an average of Rs. 46.70 in November as compared to Rs. 43.37 a year earlier), there is not only concern on how the perceived deterioration in the balance of payment (current account) will further weaken the rupee but there is also the question whether the RBI has any preferred rate of exchange as part of its ongoing agenda.

It is nobody's expectation that the Governor of the RBI would indicate, at any point of time, whether the movements on the exchange rate are in keeping with the policy objectives of the bank or not. It is not surprising therefore that Dr. Jalan has refrained from any comment as such on the current state of the rupee as against the dollar or any other currency. But his point that there is an inevitable ``herd factor'' in operation in the forex market cannot but lend itself to the interpretation that the RBI regards the depreciation of the rupee more as the handiwork of speculators than as the reflection of any impairment of the economic fundamentals.

To put it differently, even if the RBI has conceivably no preferred rate to exchange for the rupee, it has responsibility for ensuring that a steep depreciation of the rupee involving cost escalation in the Indian economy all round is averted. It is another matter that the benefits of a depreciating rupee accrue to the exporting community. To what extent the recent surge in exports - of the order of 20 per cent during April-November 2000 - can be attributed to a depreciated rupee will be difficult to quantify even if it is conceded that the turnaround in the Southeast Asian currencies has put India in a stronger competitive position in the North American markets.

Creditable as the record of the RBI has been in taming excessive turbulence in the forex market over the last two years, the question still remains whether the RBI is biased against the depreciation of the rupee as such. There is more to this question than the export lobby's facile addiction to the notion that Indian exports can compete in global markets better through a depreciated rupee rather than through a manifestly difficult process of cost reduction, given the pervasive inefficiencies in infrastructure and the high cost of credit. Could it be that the RBI is much more concerned with the servicing cost of external debt (of the order of $98 billion), in rupee terms than with allowing an admittedly narrow forex market to determine the exchange rate for the rupee on the basis of changing perceptions of the economic fundamentals? To say that the RBI is committed both to price and exchange stability and this why it seeks to intervene in the forex market from time to time (to stem the depreciation of the rupee arising from an excess of demand for the dollar over its supply) would hardly constitute a rational explanation for a policy that is claimed to be market-oriented.

The view is often put forward by some market analysts that the RBI ought not to shy away from using the ammunition available in the form of ``comfortable'' forex reserves (of around $35 billion) for dousing the perceived speculation against the rupee. There are two problems with this point of view. First, it presupposes a ``comfort level'' for forex reserves, not in relation to the overall ``vulnerable'' reserves comprising portfolio funds and NRI deposits recallable at short notice (altogether amounting to $15-20 billion) but in terms of ``import cover''. Second, the concept of ``comfortable reserves'' totally ignores the question whether or not the exchange rate for the rupee ought to reflect the strength of the Indian economy that is not a ``constant'' but is a dynamic ``variable'' with its own modulations. Granted that the forex market (even in the absence of convertibility of the rupee on the capital account) cannot be totally ``sanitised'' (or extricated from speculative influences), should the RBI continue to superimpose itself on the market? Would it be wiser for the RBI to focus on the admittedly difficult task of maintaining price stability or more precisely of targeting a pre-determined ``tolerable'' rate of inflation? With all the attendant embarrassment of confronting a permissive fiscal policy preferred by the political establishment?

Whichever way the RBI reads its mandate on the issue of the exchange rate, it is instructive to look at what the Planning Commission has been urging, as the strategic course in relation to the exchange rate. This is what the Commission put forward as its well-considered strategy on the matter, in the Ninth Plan document, covering 1997-2002. ``During the Ninth Plan, the exchange rate will need to be deliberately depreciated in terms of the average level of prices in the country, which would, given the targeted rate of inflation for the Ninth Plan period, imply a nominal depreciation in the range of 5 to 7 per cent per annum under normal circumstances.''

The Planning Commission had envisaged an average annual rate of inflation of 5-7 per cent for the Plan period. While it is true that the annual average rate of inflation for the first three years (1997-2000) had hovered around 4.5 per cent, recent trends would suggest that the rate cannot but become higher. Even apart from this ``normal rate of depreciation'' of the rupee which the Commission on ``the immediate imperative'' of encouraging ``a greater degree of outward-orientation through policy initiatives, for which the exchange rate is the principal instrument.''

Are we going along this track of ``managed float'' pro depreciation or setting our minds against a depreciated rupee and in the process running against the current of the fundamentals?

Send this article to Friends by E-Mail

Section  : Business
Previous : Rupee ends shade lower