Clutching at straws

Viewed purely from the highest traditions of libertarian principles, the Reserve Bank of India's (RBI) directive to exporters to convert 50 per cent of their foreign currency balances in banks — both outstanding as well as fresh remittances — into rupees is harsh. The Exchange Earner's Foreign Currency (EEFC) scheme enables exporters to warehouse all their earnings in a dedicated forex account. Since this money can be used for making various forex payments, including imports, it saves them the transaction costs involved in converting dollars into rupees, and vice versa. Additionally, it serves as a natural hedge against exchange rate fluctuations, particularly when the rupee is in weakening mode, as is the case now. The RBI action, allowing only half of the EEFC account deposits to be henceforth retained in foreign currency, will especially impact those exports having high import content, such as gems and jewellery, and petroleum products.

While the latest move may raise transaction costs and reduce payment flexibility for genuine exporters, one cannot, however, ignore the circumstances that prompted such a response from the central bank. A depreciating rupee scenario is always conducive for exporters to hold on to their dollars and, in this case, make gains between the time from receipt of foreign currency in the EEFC account and conversion into rupees. That, in turn, adds to the speculative pressures on the rupee, with the EEFC becoming a facility to maintain foreign currency for hoarding rather than for genuine transaction purposes. The RBI has, accordingly, not only mandated that at least half of exporters' earnings remitted to their EEFC accounts be surrendered for conversion to rupees, but also that they first utilise these balances fully, before purchasing any foreign currency from the market. These would force exporters to both increase their supply of dollars and limit their purchases from the market, helping to stem the slide in the value of the rupee.

But all such measures can only temporarily shore up the rupee, as they do not address the underlying structural issue of a widening current account deficit (CAD). This was borne out in the recent past, when the rupee plunged from below Rs 44 to well over Rs 54-to-the-dollar between end-July and mid-December. The RBI, then, responded by banning rebooking of already-cancelled forward forex contracts, and freeing up interest rates banks could offer on Non-Resident External deposits. It led to the rupee recovering somewhat to below Rs 49-levels towards end-February, before the fundamental factor — of a $ 70 billion-plus CAD in 2011-12 — reasserted itself. The latest curbs on EEFC account holders, or the increase in interest rate ceilings on Foreign Currency Non-Resident deposits, are also likely to offer only momentary respite. What the country requires are more enduring measures for boosting exports and restraining high-value imports such as fuel and fertilisers, by aligning their domestic demand with balance of payments considerations.