The Hindu Business Line : Battle of the forex bulge

At one level, the slew of foreign exchange market-related announcements by the Reserve Bank of India (RBI) in its latest Credit and Monetary Policy Statement can be seen as entirely in keeping with its approach of gradually dismantling control on transactions on capital account. But at another, more subtle, level it is also an invitation from the RBI to the horde of listed and unlisted coporates, small and medium enterprises and retail investors to join it in battling the problem of burgeoning foreign exchange reserves.

Indian corporates can now invest a lot more overseas than what they were allowed to earlier. The retail investors too are being told that they can indulge little more their fancy for overseas stocks. More significantly, resident entities have now been enabled to take speculative views on future exchange rate movements even when there is no immediate/direct exposure to foreign exchange risk. The RBI is evidently counting on the participation of even those who had until now viewed it as something remote to their interests so that a vibrant two-way movement gets established in the market for foreign currency as people with divergent views back their judgement with money.

But it is moot point if the RBI's new blandishments in themselves would help achieve this. The freedom, such as already existing, has not exactly caused a stampede of investors wanting to convert their savings into precious dollars and exit the Indian market. Mutual funds have not been able to mobilise from domestic investors sums that they are currently permitted to invest in overseas stocks. Quite apart from the fact that the domestic market offers far more exciting opportunities, there is also the investor psychology to contend with.

If the spectre of shortage and regulations imposed to counter a tendency to hoard, created a vicious cycle that was mutually reinforcing in the context of accelerating the flight of domestic capital, the new-found freedom and the dismantling of controls that are a logical consequence of it are likely to create a virtuous cycle having the exact opposite effect. When the investor realises that he can have access to all the foreign exchange that he needs any time he is more likely to disgorge all that he has accumulated rather than hoard it. The typical entrepreneur who would inflate the value of his foreign procurement and under-state his export earnings in the hope of providing for a rainy day would now flood the market either by curtailing the outflow or dumping his forex earnings merely because the regulatory action is only sending the signal that there is going to be no rain in the foreseeable future.