Rupee in the midst of financial turmoil

By C. R. L. Narasimhan

For the Indian rupee like the Indian stock markets it has not been a period of even (relative) stability or calm. Even before the recent terrorist attacks in the U.S., the rupee had come under pressure.

The reason given then was that there was a concentrated foreign institutional investor (FII) selling in the stock markets and were therefore buying dollars to repatriate their proceeds. Against the background of a faltering economic growth-practically everyone including the RBI has lowered the GDP growth forecasts- specific instances such as the fall in the rupee or the FII's selling of stocks acquire ominous overtones.

The terrorist attacks came on September 11 bringing with it unforeseen consequences for the rupee. By September 18, the rupee closed at almost Rs.48 having breached that figure several times earlier. A day later it closed below Rs.48. More recently, however the rupee has been gaining ground and that like its earlier falls ought to be attributed to the global uncertainty; Sentiment keep changing by the minute. As always the fall in the rupee value of the dollar is a sensitive subject inviting many kinds of dissertation on its probable causes, measures to check them as well as even bigger issues such as the alleged shortcomings of the current exchange rate policy.

Though in a slightly different context, the clamour for a cheaper rupee has returned. At the recent meeting of the Prime Minister's economic advisors the option of a cheaper rupee to boost exports was reportedly discussed. In the end however there has been a realisation that a single course of action, such as trying to nudge the currency downwards to fulfil specific goals, can be counterproductive. Obviously it is far more important for the exchange rate policy to prudently manage the balance of payments and insulate the external sector from global shocks.

Interestingly, exchange rate mechanism, as a topic has recently been discussed in several fora. Global experience has been such that there cannot be one single model that can be commended for all countries. Almost all of them, including India have an exchange rate administration model that can best be called a managed float. The rupee has neither a fixed rate parity with any currency or basket of currencies nor does it freely float in the markets.

Another reason giving a topical touch to the subject is because of the experience of two countries -Malaysia and Argentine. The former adopted a fixed parity for its ringitt and imposed controls to back it up. Despite the initial criticism over such an unorthodox approach, Malaysia did manage to recover faster than many of its East and South East Asian neighbours who were all ravaged by the currency turmoils. Currently however there is speculation as to whether the parity will hold except at a grave cost to the Malaysian economy. At the other side of the globe, Argentine adopted the currency board experiment. Basically it involved dollarisation of the domestic economy. The circulation of the domestic currency, the peso, was made dependent on the stocks of dollars with the Argentine central bank. The country is now in the midst of an economic crisis although there is no unanimity as to whether the currency board arrangement alone is to be blamed.

What has been the Indian experience? The RBI (in its Annual Report) looks to the external sector as a whole rather than particular facets such as exchange rates and makes the following points. The global economic scenario is not particularly cheerful. The leading economies are in the midst of a downturn and this makes the prospects for emerging economies highly uncertain. The U.S. economy might start recovering only from the beginning of the calendar year 2002.The Euro zone's growth has been moderate and the Japanese economy has structural problems too. It is certain that private capital flows into India will be significantly less this year compared to 2000.However,compared to many other Asian countries which have been adversely hit by the U.S. slowdown, India is likely to fare better. Even the negative consequences of a slowdown in software exports to the U.S. can be insulated to an extent through diversification. According to the RBI foreign direct investment flows are expected to be relatively unaffected, while the prospects for portfolio flows are mixed.

In RBI's view, exports hold the credit to a sustainable balance of payments. On September 24, a special export promotion package for exporters has been announced. A whole range of measures to boost exports has been undertaken. During the Tenth Plan period the level of current account deficit is expected to go up substantially.

Net capital flows into the country will have to grow exponentially, says the RBI while making the important point that policies for capital flows would need to be suitably adjusted ``to ensure a preferred hierarchy in flows'' so that the capital account is stable. Elaborating on capital account liberalisation, the central bank says that the pace would critically depend upon domestic factors (financial sector reform, fiscal adjustment) and the evolving international financial architecture.

On managing exchange reserves, the RBI report highlights the fact that ``liquidity risks'' are now reckoned with. Both identifiable factors and other contingencies are taken note of.

These include the size of the current account deficit, the size of short-term liabilities, movements in repatriable deposits of non-resident Indians and unanticipated pressures on balance of payments arising out of external shocks.

It will be interesting to see whether official policy can accommodate the shocks caused to the financial system in the wake of the U.S. attacks. Almost three weeks after the Black Tuesday September 11 the picture is grim.

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