Ways to handle forex crisis

In the context of the current turmoil in the forex market, many policy measures are under discussion and implementation, including central bank intervention. The latest regulatory measures to curb arbitrage opportunities are on the right lines. The Reserve Bank of India (RBI) has capped the position limit in the exchanges for trading currency F&O at $100 million or 15 per cent of the OTC market.

As the risk of rupee depreciation continues, to attract overseas money, it has also allowed banks to accept Foreign Currency Non-Resident (FCNR) deposits as collateral for granting loans to domestic borrowers to meet working-capital needs.

It should not hesitate to go one step further, as suggested in my article “External sector looks vulnerable” ( Business Line , May 12, 2012) to encourage forex loans by banks out of the FCNR deposits.

The $20billion-plus of forex reserves, frittered away in market intervention recently, did not result in any enduring stability. It could have been utilised better by opening a refinancing window for such loans. The terms could certainly be made attractive vis-à-vis those obtaining in external commercial borrowings.

Rupee depreciation

The depreciation of the rupee has to be fought on both the demand and supply sides. These loans could have been out of the fresh inflows of NRI deposits after the interest rates are deregulated.

The rich NRIs constitute a class of professionals, academics, international civil servants, et al , different from those workers who make remittances, although there may be persons coming under both categories. The former with immense wealth are influenced by yields and the latter by rupee depreciation.

The central bank could, perhaps, take another look at the relaxation in intra-day net open position in forex deals allowed on May 10 and examine whether it has worked to its intention.

It was done ostensibly to improve liquidity in the market. Liquidity for what and for whom? Though funds are fungible, there is no shortage for financing genuine trade in goods and services that constitute only a small fraction of the total transactions. The bulk of the liquidity is required for inter-bank speculative deals, either as principals or as agents.

Market intervention

The editorial “Staying the hand on forex” ( Business Line , May 22) has raised some pertinent issues on market intervention. In the real-time world of market transactions, the value of the exchange rate is determined by the demand and supply forces.

The search for equilibrium is never-ending like the one for the Holy Grail. A quick and intuitive analysis of the market trends shows that market intervention has been counter-productive and has aggravated market volatility instead of ameliorating it due to speculation about its extent and timing.

The mighty Bank of England could not stand up to George Soros, the forex trader, in the pound sterling crisis of September 1992. The Chancellor of the Exchequer of UK rued that Soros had made $1 billion overnight by short-selling the sterling!

Today's forex managers, who were young at that time, would do well to go through the episode. The RBI should undertake a cost-benefit analysis of its market intervention.

Imbalance in flows

The recent stipulations on the rupee conversion of foreign currency in the accounts of exporters and other categories are not likely to bring in any relief as they do not mean any net accretion to supply to have an effect.

They mean that certain banks would be issuing rupees, leading to a liquidity problem, unless the money returns to them. In other words, there could be an intra-system imbalance in flows though the system.

Would it not be better for the central bank to buy these dollars and build up its depleting reserves? There could be a delay in the repatriation of the forex proceeds by exporters until the deadline is reached.

We may expect the repo transactions rising in the coming days to peak around the middle of June due to advance tax payments. Repos for funding forex speculation cannot also be overruled. The RBI may have to continue to engage in retroactive monetisation of past fiscal deficits through buybacks of securities on a large scale.

Tobin tax

One proposal that was talked about in the past but missing in the discussion now is the Tobin Tax recommended in the wake of the breakdown of the Bretton Woods system in 1971.

James Tobin suggested a penalty on short-term financial round-trip excursions between currencies influenced by speculative forces in the market.

In the current atmosphere of the politicians and the corporate sector pressurising the central bank to make its policy pro-growth, the speculator knows that the probability of an increase in interest rate is low in the near future despite the persistent inflation. It guides him in taking a position on the exchange rate. There are variations such as Currency Transaction Tax and Financial Transaction Tax.

It is time the RBI constitutes an expert group to take a total view of the issue of the stability of the forex market, taking cognisance of its interface with monetary, fiscal and debt management policies and come out with feasible recommendations within a month.

The group should be broad-based, including all stakeholders. In the meantime, the central bank should continue with administrative and regulatory measures to curb speculation.

In this context, it can examine the introduction of a circuit-breaker on lines similar to the stock market, incorporating amendments mutatis mutandis .

(The author is an economic consultant.)

COMMENT NOW