Creeping Adjustment Of Rupee Better
The Reserve Bank of India should ensure a creeping adjustment of the exchange rate so that there are no sudden jumps in the rupee's value, say experts. In addition, it should take firm steps to curb speculation in the foreign exchange market to avoid the excessive depreciation that has taken place in the past few weeks.
The RBI could do with a few basic lessons in how to run an effective monetary policy, feel experts. While the basic requirement of a successful monetary policy is that it should be opaque and unpredictable, the RBI is too predictable to be able to run a successful monetary policy, they add.
A look at the movement of the rupee's value since 1994 indicates that depreciation over the period has been in keeping with the rate of inflation. For instance, between January 1994 and September 1999, the rupee depreciated by almost 38 per cent, while the index for wholesale prices increased by about the same amount.
Therefore, over the long run, the rupee does depreciate to its real value. The problem is with the path it has been taking to reach it.
Between 1994 and now, the rupee has undergone three phases of sharp depreciation. The first was between September 1995 and February 1996, the second
between November 1997 and
June 1998. The third is the
current phase.
However, the adjustment, which takes place in fits and starts, creates adverse expectations in the forex market. This leads to greater swings in the rupee's value in the adjustment period than would otherwise have taken place.
A creeping exchange rate would avoid adverse expectations in the foreign exchange market and lead to greater stability in the value of the rupee, feel experts. It would also avoid the ballooning of the oil bill when the rupee depreciates sharply.
Moreover, benefits to be derived by exporters due to a cheaper rupee are likely to be negated by the rising import bill, an unnecessarily weak rupee does nothing to improve the trade balance.
The major problem, feel experts, lies in RBI's method of intervention. The depreciation of the rupee is triggered by foreign institutional investors outflows.
The RBI's usual method of intervention is to prop up the rupee in the initial stages and when declining reserves make it impossible to maintain the rupee at its existing level, to let it depreciate. The rupee depreciates and then stabilises, as perceptions of a stronger rupee prompt purchase of rupees.
Speculators end up making a pile in such an eventuality. For instance, if they took out Rs 1 billion at Rs 40 to a dollar, they get $25 million, while they have to get back only $ 22.22 million at Rs 45 to a dollar, to get the Rs 1 billion.
However, a better method would be if the RBI does not attempt to prop up the rupee in the initial stages and lets it depreciate as reserves flow out.
Then, an unexpected intervention to push up the rupee, would do more to deter speculators. A rap on the knuckles, when it is least expected, is just the prescription the RBI ought to adopt, feel experts.
While the RBI also has to keep in mind the interest rate movements, it does need to learn how to run an effective monetary policy, say specialists. Even now, there are enough forex reserves in the apex bank's kitty to allow it room for manoeuvre. Although pumping in dollars will push up interest rates and increase fiscal deficit among, the RBI needs to show its muscles once in a while, they feel.
Also, while the central bank has no control over how FIIs place their money, it does have control over how banks operate in the forex market. With only a few nationalised banks controlling a large chunk of the forex market and the demand for forex being predictable to an extent, the RBI can take corrective measures.
However, once banks cease to be under RBI's control, it may well have to adopt the creeping adjustment route to avoid excessive movement in the forex market.