The Hindu Business Line : Rupee: Rising tide

The average ‘dollar’ fell from Rs 44.17 on March 16 to Rs 40.36 on August 3, 2007 as the rupee rose. This shaved Rs 76,000 crores off March 16 forex reserves at Rs 833,000 crore.

Actual losses will depend on exchange rates prevailing at the time that reserves are encashed. We are in the meantime ahead of the game because of the $33-billion increase in dollar-denominated reserves, but this has only added to our problems.

Investors scramble to build up positions in currencies that are moving up. If inflows are not taken off the forex market, this could trigger even larger flows. The sooner self-perpetuating vicious cycles are broken, the easier they are to break.

But costs of mopping up surplus forex are high; approximately Rs 250 crore on every billion dollar taken off the market. This amount has to be foregone or paid out each year on immobilised balances until reserves (presently aggregating $ 222 billion) are liquidated.

Given the Finance Ministry’s desire to pass the buck, the RBI gradually hiked zero interest bearing cash reserve ratios (CRR) to the present level of 7 per cent. Because of this, bank balances impounded with the RBI grew twice as fast as balances under the Market Stabilisation Scheme (impounded sale proceeds of central government bonds) between March 16 and July 27, 2007.

Thanks to tail-end effects of the most recent CRR hike, for the week ended August 3 too, bank balances increased faster than MSS balances, but only in absolute terms.

The option to hike CRRs having pretty much played itself out, the ceiling on MSS balances has been revised to Rs 150,000 crore.

Rs 100,000 crore were already outstanding under the MSS on August 9, the day the ceiling hike was announced. So even after the hike, the RBI was left with a cushion of just $ 4 billion.

The increased ceiling was accompanied with an announcement that a review would be triggered when MSS balances reached Rs 135,000 crore. With the brunt of the burden now borne by MSS, which rose Rs 7,000 crore between August 3 and August 9, it will not be long before such a review becomes necessary.

Market-watchers are also aware that the hike in the MSS ceiling represents a 180 degree turnaround of the preferred policy of turning away from MSS.

Clearly further steps are called for. The ceiling on ECBs for domestic use was one such step. It may not be the last.