The Hindu Business Line : Why the RBI wants reform

The appeal by the Reserve Bank of India in its latest Annual Report for priority in policy formulation and decision-making in such areas as infrastructure, agriculture and so on has to be seen in the context of the challenges it has faced in managing the exchange rate. Despite its intervention in the currency market from time to time, it has not been able to prevent the rupee’s appreciation vis-À-vis the dollar although such intervention mig ht have succeeded in curbing excessive volatility in the exchange rate. Clearly, when it comes to keeping the currency stable, the best of monetary management skills is not proof against a host of global factors such as a sluggish US economy, hardening commodity prices, and private capital in search of profits in emerging economies. Most emerging market currencies have also seen a significant appreciation of their currencies against the dollar.

The RBI perhaps recognises that the days of the currency market correcting itself at the merest hint of a frown from it are over. The underlying causes for a hardening rupee now are of a more fundamental nature than mere speculative or errant behaviour by market participants. The central bank is confronted with policy options that are not without costs to some sections of the economy. For instance, if it intervenes and buys dollars in the market to hold the rupee, liquidity in the system goes up. That has adverse implications for price stability in the economy. If on the other hand, it decides to mop up such surplus liquidity, it needs to issue more government securities than what is dictated by the Government’s budgeted spending programme. That too may not be very palatable as it increases the fiscal deficit and pushes up the interest rates in the economy. A neat solution to the problem would of course be in the economy slipping into higher gear, and stepping up investments and output. But for that to happen, the Government needs to get its policy reform act together. For instance, freedom for electricity producers to seek their own customers can cause a dramatic spike in investments in this sector. Better quality decision-making or a focused approach to administration can similarly speed up flow of investments in other sectors.

Plaintive though the RBI’s cry for reforms, the corporate sector would do well to not place too much hope on such an outcome. In the near term the rupee may well stay firm. Fortunately, many other emerging market economies with which India competes are also in a similar predicament as their currencies too have appreciated. But customers in the West are known to drive a hard bargain and would be loath to approve price hikes merely because exchange rate gains have squeezed current profit margins. The more India enhances the proprietary content in its product and service offerings to the world, the greater is the likelihood of it staying competitive despite currency gains, something that Japan demonstrated in the 80s.

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