A multipronged strategy to shore up the rupee

By C. R. L. Narasimhan

The Reserve Bank of India diktat to exporters allowed to keep part of their earnings in dollars is an interesting development and has to be understood in a larger context than is apparent. On August 14, the RBI asked exporters who hold dollar denominated EEFC accounts to repatriate 50 per cent of their balances (as on August 11) into the country in about 10 days time. Since the direction was given at a time when the rupee was fast depreciating against the dollar, it was naturally inferred that the $1 billion or so which were expected to come in would relieve the pressure in two ways: one, by adding to the country's forex reserves; when the RBI has to intervene by supplying dollars (selling) the extra dollars will naturally count. Second, if the estimated dollars do come in, it may just turn out to be the catalyst spurring other inward remittances. The RBI can then claim success on the more important parameter of influencing the market sentiment.

Over the past few weeks it has been the negative sentiment as much as the well-known mismatch between demand for and supply of dollars that had weighed down the rupee. That is also why the classic rupee support measures of June 21 - a hike in the Bank Rate and so on - has had little corrective impact on the rupee dollar equation.

Sentiment matters most

In fact the sentiment for or against a particular currency is something which everyone connected with forex markets has to reckon with. Every serious market player - he need not necessarily be "a speculator" - has to take a view on its near term prospects in relation to another currency.

How have the exporters and importers viewed the recent rupee declines? As the RBI said in its August 3 press release, speculative forces in the forex markets have been kept under check as a result of certain earlier measures.

But even outside of speculative demand for foreign exchange, genuine "leads and lags" in respect of genuine import demand and export realisation can have a large impact on the demand-supply position in the short-run.

Because of the negative sentiment against the rupee, importers rush in while exporters wait for a higher realisation. The former would like to buy the dollars not only for their immediate needs but for future requirements too. (This is possible through forward contracts). On the other hand, the exporters and others who have foreign exchange wait till the last possible minute to convert into rupees.

Hence, it is that even without pure speculation there could be genuine short-term pressures in the forex markets. As the RBI says it has to take appropriate measures to stabilise expectations. It is in this context the directive to the EEFC account holders makes particular sense.

The RBI approach is based on two premises: the recent sterling export performance has not caused a corresponding increase in forex inflows into the country. Between February and June this year exports were around $18 billion. The implication is that the exporters are delaying their remittances, hoping that when the rupee depreciates further they can book a larger realisation.

Second, with the onset of Foreign Exchange Management Act, the rupee is virtually convertible on current account. Making this point, the RBI says that with the commencement of the new regime incentive schemes such as the EEFC have probably outlived their relevance.

However, export organisations have a different viewpoint. Targeting the exporters' money to shore up the rupee may not by itself help correct the imbalance, they say.

This point has some validity. The EEFC account balances are now in the region of $2 billion. By forcing half of it to be converted into rupees, the RBI will not be achieving anything consequential. Further, exporters have to be savvy about matters relating to exchange rates.

One of the main reasons why facilities such as the EEFC were first given was that export activity had to be rewarded and exchange earners given special incentives.

In India like in most other countries the American dollar is the benchmark, the currency against which every other currency's exchange rate is measured. Part of the reason of course is the primacy of the dollar in international trade and finance, which even the emergence of the euro has been unable to challenge.

In inter-bank trades seldom does one find a quote for the dollar but only for some other currency say the British pound or the yen against the dollar.

The dollar-centric approach is a fact that cannot be wished away. In India that approach has had one unfortunate consequence. Even the RBI which has quite correctly - but so far unsuccessfully - been trying to say that forex rates are more than just the dollar-rupee rate will admit that is practically impossible to change that perception easily.

So what other practical steps can be taken to shore up the rupee? The real cause for the pressure on the rupee came from the stock markets with FII outflows causing a dent in forex reserves as well as on the stability of stock prices.

Nearly $1.8 billion of forex reserves have been depleted from the beginning of the financial year. The other major reason is that foreign direct investment has not materialised to the extent hoped for.

Over both - FII and FDI - the monetary policy can have only an indirect influence. But a less volatile forex market and a more stable rupee, which the current RBI measures hope to deliver, will change the sentiment for the better.

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