Exchange Rate Turmoil...

The central bank's position is that it does not try to second guess the market. It seeks to ensure orderly trading, prevent excessive volatility and curb speculation which creates the volatility. But invariably signs of initial RBI disinterest are interpreted as either active connivance in favour of a depreciation or simply an acknowledgment of inability to fight market forces. As a result, speculative operators push the limits to test the RBI's resolve. The rupee initially takes a toss. Seeing this, importers rush in with their orders; exporters delay inward remittances for better realisation. Soon there is a genuine mismatch between demand and supply. By this time, it is too late for the central bank to halt the slide by market intervention alone. It has to resort to administrative measures as it did in January and August 1998.

By obliging speculators with a response every time, the central bank only feeds the psyche. This time, it loaded a 50 per cent interest rate surcharge on import finance and a penal 25 per cent rate of interest on overdue export bills, apart from threats of other measures. But despite these measures, on Friday the rupee still slid further. Because it has to bring out heavy artillery, the central bank sends out a signal that there is something genuinely wrong with the market when there is none.

A market development calls for a market-oriented response. The market is characterised by many small suppliers of foreign currency (exporters) and a few large importers whose bulk orders can create large swings. The RBI is obliged to maintain stability by supplying dollars `as and when required'. But by intervening though administrative measures like taking the oil and defence import payments out of the market, the central bank reinforces the notion that it is working towards an implicit exchange rate target.

Central bank intervention is a essential when there is a managed float. More intervention or less is not the issue. What it has to do is intervene effectively and through market forces. Unfortunately, it has always been accused of first being late in making the call and then taking recourse to administrative measures that denies everyone the chance to see what the market comes up with. At the end of the day neither the bank nor the traders are any wiser. The central bank should not, as it claims, second guess the market. The market should learn to guess RBI's signals right. Otherwise what the market will infer will be sub-optimal,

thereby loading a cost on the economy. The RBI should provide a guiding hand to the operators so that they, through the market, can discover the true level of the currency. Instead, if it crushes a `rebellion' by

`speculators' every so often it does not help the market to learn to do what it alone ought to do.