Rbi Plan May Let Re Move Freely

Reserve Bank of India seems to have reviewed its exchange rate management policy to allow the rupee to move more freely and intervene only to curb excess volatility in the market.

Over the last couple of days, the RBI intervened by dollar sales only to curb excessive volatility which occured when the rupee crossed the 40 limit. In fact, when the spread between the buy and sell quotes widens over 10 paise the RBI intervenes. By not supporting the rupee at a particular level, the exchange rate will be market-determined and less prone to speculative attacks, say bankers.

Bankers term the rupees recent depreciation as a correction after its earlier overvaluation. Also, given that the dollar is strengthening worldwide, an exchange rate of Rs 40 to Rs 42 per dollar seems comfortable. Bankers point out that in mature markets, currencies are allowed to float freely. The market exchange rate is accepted as a true, non-biased value by market players. While this has not hampered trading, it has prevented speculative attacks on the currencies.

 

On an average, major currencies such as the mark, yen and Swiss franc, decline by about 10 to 15 per cent against the dollar, annually. Besides, there is some degree of predictability about the currency movement which prevents undue speculation. By contrast, the rupee has seen periods of unnatural stability followed by sharp correction which has encouraged speculation.

This is attributed in a good measure to RBI intervention. On account of the central bank supporting the exchange rate at various levels, like 31.37 or 35.75 or 36.20 for prolonged periods, the rupee has not moved as much and as smoothly as currencies in advanced markets. This is despite the fact that these countries have stronger economic fundamentals than India in terms of inflation and fiscal deficit. As a result the Rupee has been appreciating in real terms.

In fact, in most emerging markets, central banks traditionally intervene to keep the nominal exhange rate stable which is not in keeping with the characteristic of an open economy. This results in an exchange rate which was clearly unnatural and leads to uncertainty about its sustainability and future course.

With respect to the rupee, bankers felt that the RBI by constantly intervening to support the rupee resulted in an exchange rate stability which is unnatural leaving the market to speculate what the real exchange rate was. For instance, while capital inflows in the country resulted in excess supply of dollars, the RBI, instead of allowing the rupee to appreciate in nominal terms, intervened in the market.

This resulted in complacency particularly among corporates with forex exposures. Bankers argue that had the RBI allowed the rupee to appreciate, when the rupee was at attractive levels, corporate demand would have picked up leading to a natural depreciation of the rupee to a more realistic level.