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Thursday, Apr 08, 2004

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Forex market: The Indian script

V. Kumarswami

The dalliance with capital account convertibility is hurting people dependent on interest incomes, bankers and exporters.

THE last week of March saw extreme volatility in the forex markets comparable in magnitude to that seen in the aftermath of the East Asian crisis and the 9/11 attacks, although the rupee gained in this case. But this time the script and drama are entirely our own.

The recent episode is worrisome for more reasons than one. Most market players appeared clueless for a couple of days. The Reserve Bank of India's action seemed inexplicable when its Governor dismissed that day's rather high volatility as a sign of flexibility — something the market was not prepared for. And the next was the inflation bit from the Finance Minister.

A more benign statement like ``we are discussing the matter and we will do what is in the interest of all concerned'' by the Finance Minister would have helped cool matters. But his statement that it is a part of the inflation control mechanism coming on top of the RBI Governor's statement seemed only to confirm that both the policemen were on a standby mode and would do nothing to arrest the mayhem. What is more worrying is that these events might repeat in the future.

  • If the foreign institutional investor inflows into the stock market and the sudden upsurge in forex for PSU subscriptions did play a large part in this round, there are more big-ticket issues such as of the ICICI and TCS in the offing.

  • The RBI has completely run out of sandbags of securities to shore up.

    It has been claiming that it is only a `stabiliser' to smooth out volatilities and is not working towards any particular levels of exchange rate. But, then, stabilisation generally means the RBI would have sold as much as it bought over the years and, thus, the situation would not have come to the current pass. So in practice, it has been one-way intervention — just buying dollars. Not that one can hold the RBI wholly responsible as the blame lies elsewhere. It is the culmination of lopsided capital account convertibility (CAC) measures being pursued over the years and the false pride in swelling reserves.

    In an analogous situation when money is coming at ever-lower interest rates, what should a corporate treasurer do? Should he restrict his borrowing to what is needed to prepay expensive loans and fund his capital expenditure programmes, or keep borrowing to keep a high cash position just because it is coming cheap and not that he needs it?

    Any goal-driven treasurer would be constrained to limit his borrowings to what is needed than by the `juiciness' of the offer.

    This "don't borrow what you do not need" unfortunately does not seem to apply to CAC. In opening the capital account, the measures have not been as bold as they were vis--vis during the current account relaxation. Caution is no doubt needed — for we can hardly afford to slip up — but to the point where the very purpose of the move is getting defeated is surely not right. We are miles ahead in liberalising inflows but fall way short on outflows without knowing what we want to do with the funds we are amassing. Beyond the "defensive reserves" of two-three months import levels the policy-makers have a clear-cut plan on how to use the reserves.

    The original CAC committee neither put a cap nor envisioned a situation where there would be so persistent an inflow leading to pressures on interest rates, exchange rates, and export competitiveness, and even employment.

    But, then, caution always seems to have bordered on the panic. When the RIB bonds were issued, India was sitting pretty with six and eight months imports' cover. And the drop down in reserves those issues occasioned was hardly in terms of days and weeks. But we panicked and made large issues at high interest rates just to feel safe. Even today, there seems no plan of how best to use the existing reserves.

    The measures on outflows announced from time to time are not even half-measures. This has started telling on the exchange rate. Given the inflation differentials, the appreciation of the rupee against the dollar is nowhere being fully explained by the travails of dollar elsewhere.

    It is baffling why it is considered prudent to restrict ECB (external commercial borrowings) and FCCB (foreign currency convertible bond) borrowings (to finance only capital expenditure) but not equity issues. If the intention is to plug inflows till they are actually needed for capital expenditure, they should be linked to imports and the rule should be applied in equal measure for equity as well.

    Or in the Government's case money from disinvestments should have been earmarked only for prepayment of government's external loans.

    The fall of the dollar and the recent steep downward revisions in Duty Entitlement Passbook (DEPB) Scheme have started affecting exports. Using the recent export year-on-year growth figures to reason that these are unlikely to affect exports is not tenable for it takes a while for the effect to be felt. No one can afford to ignore a 10-15 per cent fall in sale price without a corresponding lowering of costs. Where has such a steep fall in costs come from?

    The dalliance with CAC is hurting, from savers and people dependant on interest incomes to bankers, who have been finding the competition from overseas funds a little too hot to handle, and the exporters.

    Surely, exporters have also gained by way of lower interest. But what they gain is 2-3 per cent against losing 7-8 per cent in export sales.

    (The author works for a large chemical manufacturer-exporter. The views are personal.)

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