NEW DELHI: The sudden depreciation of the rupee against the dollar by more than 13% in just 10 weeks may be sufficient to take care of the last two years’ internal erosion of the rupee value, and there cent hardening of dollar in the international market. But other uncertainties in the Indian political economy and the possibility of a depleted foreign exchange reserve may be creating panic in foreign exchange markets, the finance ministry and the Reserve Bank of India (RBI), are deeply concerned. It was in July this year that the RBI routed more debt repayments through commercial banks to depreciate the rupee to account for inflation during the last two years.
The stability in the exchange rate at Rs.31.37 to a dollar for nearly two years had confounded policymakers. They wanted a depreciated rupee as an incentive to export. Bui, the actual fall of the rupee has been much more than they had anticipated.
“It is like a genie being let out of the bottle, and finance ministry officials do not seem know how to put it back or what form it will take,” a foreign exchange expert said on condition of anonymity. The Reserve Bank governor and the top brass of the finance ministry are understandably concerned. They are equally tightlipped, except saying that India will not be another Mexico, as the fundamentals of the economy are still strong.
But the foreign exchange market does not necessarily move on fundamentals, It moves on expectations, ‘and the expectation is that the rupee will weaken, which has prompted the importers to rush for forward over resulting in the surging demand for dollars, Simultaneously, the exporters have reduced selling dollars, hoping for killing when the rupee weaker further, The result is an acute shortage of dollars in the forex market ‘and the continuously sliding rupee, forcing the Reserve Bank to intervene.
The issue of intervention has posed some formidable problems for the economic policy makers. Various options were considered to check the rupee slide, subsequently, the RBI intervention (selling dollar) in the foreign exchange market became substantial which has kept the rupee between Rs 35.20 and Rs 35.75 to a dollar.
There is however, a danger, If the panic in the forex market does not die down in a couple of weeks, and the RBI has to intervene significantly ‘every day, the reserves would be depleted substantially, What happens after that? With the RBI incapacitated to intervene, there could be a run on the economy.
Alternatively, in the absence of intervention, the rupee could drop to 40 against the dollar or even more, which intern, could trigger a capital right, It ‘would also mar the election prospects of the ruling party, Obviously, both the options are sensitive and risky. “Whichever way you go, you may strike a blind alley,” a forex market analyst said.
North Block officials and the RBI governor are hoping that the down side of the rupee will soon ebb once the pericky importers exhaust their demand for dollars, The million dollar question is how soon.
Experience of other countries suggests that the intervention by the central bank has often been ineffective in controlling the exchange rate.
It is, however, obvious that the foreign exchange market is closely watched by policymakers. Some measures to restore confidence in the ‘strength of the rupee if the RBI intervention fails are not ruled out.
Article extracted from this publication >> November 3, 1995
