The Hindu : RBI against uni-directional perceptions on rupee

Online edition of India's National Newspaper
Monday, May 05, 2003

Business

Business

RBI against uni-directional perceptions on rupee

The RBI has been quite explicit about uni-directional moves not being sustainable but the audience does not seem to be listening. The market continues to take short positions in the dollar and long positions in rupee interest rates.

AN INTERESTING characteristic of the Reserve Bank of India's credit policy statements, in recent times, has been the focus on the rupee's exchange rate. This has been particularly evident since the present RBI Governor took office in late 1997. The recent policy is no exception.

What is even more interesting is the dramatic transformation in the nature of the exchange rate issue which the RBI addresses in its policies. If from 1997 to 2000 the focus was on tempering market expectations about an ever-depreciating rupee, the RBI is now faced with a metamorphosis. "Reversing" from a historical downtrend of around 5 per cent per annum, the rupee is up 3.5 per cent in the past year (from a low of 49.05 against the U.S. dollar in May / June 2002 to its present level of 47.35).

The broad market trend still appears quite bullish for the rupee and therefore the RBI is addressing a different issue now; it is seriously attempting to dampen market expectations about a continued appreciation of the rupee.

Uni-directional market movements — be it in currencies or bonds — is quite common in India. The RBI has been quite explicit about uni-directional moves not being sustainable but the audience does not seem to be listening. The market continues to take short positions in the dollar and long positions in rupee interest rates.

To a considerable extent, the market's confidence in the sustainability of the broad directional trend now — appreciating exchange rate for the rupee and lower rupee interest rates — seems to be well-grounded. Global dollar weakness, generally higher levels of risk in overseas markets and India's fairly robust export performance are resulting in big flows into the rupee, as for many other emerging market currencies. As for interest rates, the RBI has chaperoned rates down in the past four years with such consistency that it could be difficult to give it all up and reverse direction suddenly. Quite apart from these, the macro fundamentals — in terms of the currently measured inflation and inflation expectations, credit demand, aggregate demand in the economy — are not in such a configuration as to necessitate immediate monetary tightening. The process of tempering market expectations and bringing in two-way perceptions has necessarily to be gradual and incremental in such a milieu.

So, it is not surprising to see the RBI employing "moral suasion" tactics, initially, on both the exchange rate and interest rate fronts to get the market to see its point of view. Discrete policy decisions also have followed the "moral suasion" strategy.

Curbs on foreign currency borrowing

The decision not to permit higher foreign currency borrowing limits (in the overseas markets) for the banking sector is one such policy decision. This move was advocated to meet the enhanced level of foreign currency credit demand from the Indian corporate sector in an environment marked by a shortage of lendable dollar resources.

The RBI's perception that one-way bets against the dollar have gone far too much appears to be so strong that it does not favour any measure that will provide further ammunition to dollar sellers.

Though immediate statistics are not available, the RBI has stated that the level of unhedged foreign currency borrowings of the corporate sector is now very high — on the back of expectations of continued rupee appreciation. (It is unfortunate that genuine foreign currency credit demand — from the export sector for example — has not found any policy relief in this environment ).

The phenomenon of a shortage of lendable dollar resources itself is quite interesting and even a little anomalous when viewed in the backdrop of surging capital / other flows into the domestic economy. This has to do with the RBI's policy of absorbing the market flows itself (with a view to building the reserves, keeping the rupee from appreciating too much) rather than allowing the flows to keep circulating between banks and other borrowers in the system.

It is a difficult and delicate game — managing and attempting to modify market perceptions in an economy and financial system now exposed in a significant way to global trends and developments. The task is even more critical when viewed in the backdrop of the RBI's multiple tasks — of being exchange rate manager, custodian of the country's external reserves, supervisor and guarantor of the well-being of the country's financial system.

T. B. Kapali

(The author is Asst Vice President (Treasury) in ING Vysya Bank. The views expressed here are personal.)

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