The Hindu Business Line : Exchange rate and debt burden

An additional benefit of a strong rupee is the fall in the real value of external debt, which is the volume of goods and services to be exported to service the debt.

THE Finance Minister, Mr Jaswant Singh, is reported to have stated that: "The value of the rupee is market determined. The RBI manages the situation and it maintains orderly market conditions. It is erroneous to conclude that the exchange rate is being used to manage inflation."

There seems to be a contradiction here. The Finance Minister cannot say that the exchange rate is managed to maintain orderly conditions in the market and still claim that it is market determined. In advanced economies, one seldom hears central banks or governments admitting that they have intervened to manage the rate one way or the other.

That a strengthening rupee is good for imports and domestic prices is well recognised. But the fact that it helps exports also where imported inputs account for a substantial portion of the output is not reckoned with so well. This is true of such goods as gems and jewellery, a major export item, where imported inputs constitute a major proportion.

It is true also of petroleum imports (crude and products), a major input for exports, which accounted for 28.7 per cent of the total import bill of $61.4 billion in 2002-03 (Report on Currency and Finance 2002-2003, Reserve Bank of India, p. 99). An additional benefit that is not recognised is the fall in the real value of external debt, which is the volume of goods and services to be exported to service the debt.

When the rupee fetches more forex, ceteris paribus, a lower volume of exports is required to service the same debt. The theoretical literature on the consequences of the variations in the exchange rate generally deals only with its impact on imports, exports and reserves and not on the debt burden in local currency. This was first dealt with in the Report of the Policy Group on External Debt Statistics of India (1992).

When the country plunged into a balance of payments crisis after the first Gulf War, the RBI had effected a large downward adjustment (euphemism for depreciation) in two stages, on July 1 and 3, 1991, working out to 17.38 per cent vis-à-vis the then intervention currency, the pound. And soon, the exchange rate was fixed at close to Rs 26 a dollar (Reserve Bank of India, Annual Report 1991-92, p 79).

In the nine months ended December 1991, the external debt rose by Rs 42,488.10 crore, of which, as much as Rs 37,939.50 crore (89.3 per cent) was due to exchange rate variation. Now the situation is reversed. External debt rose from Rs 4,71,500 crore ($101.1 billion) as at end-March 2001 to Rs 5,11,200 crore ($112.10 billion) in end-December 2003.

However, the rupee value of the debt would have been Rs 11,500 crore more had the exchange rate on the latter date (Rs 45.61) had remained at the level in end-March 2001 (Rs 46.64). Thus, the gain in debt level owing to the appreciation of the rupee against the dollar amounted to Rs 11,500 crore.

Considering the steep decline in the value of dollar since end-December 2003 one can easily guess that the fall in the debt burden would be substantial — external debt data beyond December 2003 is not available as yet. The benefit should be sustained by maintaining price stability.

It is obvious that the RBI's priority right now is controlling money supply and nipping inflationary expectations in the bud, keeping in view the time lag involved. In this process, it has nearly exhausted the securities in its stocks and has had to resort to issue of market stabilisation bonds.

The creation of more bonds will strain the Government's resources, in terms of the interest to be paid; this has already landed the country in an internal debt trap (borrowing or selling assets for paying interest).

The Expenditure Secretary, Mr D. Swarup, is reported to have said that the Government has a surplus of about Rs 15,000 crore in its account with the RBI. In the normal course when the Government clears its Ways and Means Advances account with the RBI any `surplus' is invested by the central bank in Government of India securities — a sort of buyback from the RBI. Would it not be better to buy back the loans from the market? Through its open market operations (OMO), the RBI can buy the securities with high coupon payment issued in the earlier years, when interest rates were high, though it may result in some capital loss. Profits in treasury operations will be an incentive to banks to sell securities. It will mean the transfer of ownership of securities from the market to the central bank.

The Government will then have to pay interest to the RBI and not to banks. There are two salient aspects to be noted in this proposal. The interest payment to banks also creates money, straining the resources of the central bank further in its OMO. On the other hand, the interest burden on the government is reduced. Payment of interest to the public is an outgo from the government. But a similar payment to the RBI returns at the end of its accounting year by way of a transfer of a part of its net income to its owner.

However, there is a caveat. Buying back securities would mean injecting money into the system which is, of course, not desirable. The Government's surplus has arisen owing to divestment proceeds and better revenue collections. To that extent it implies an absorption of liquidity. So the buyback proposed may be only returning the funds to the market and may not mean a large net addition to money supply. Even if there is a net addition, it can be neutralised by the bank selling the dollars it has in abundance.

Forex intervention by the central bank is also in the nature of OMO. This may sound odd at a time when the reserves have exceeded $116 billion — with no let-up in the inflow of funds — the central bank is engaged in containing rupee appreciation and money supply. However, from time to time, one still reads about dollar shortage in the market, leading to sharp swings in rupee value — not a sign of stability. Going by the proposal, the central bank would have to, besides ensuring orderliness, intervene in the market on such occasions, keeping in view the objective of buyback of securities as well.

The RBI should enter the market to sell dollars in times of scarcity; at present, it does so only to buy them, because of the deluge. In a medium-term strategy of pro-active debt management, timing is crucial. The repurchased securities could again be unloaded when there is a need to absorb liquidity, obviating the use of market stabilisation bonds. It will be a win-win situation. There is no Catch-22 here.

(The author is a former officer-in-charge of the Department of Economic Analysis and Policy, Reserve Bank of India.)