Tarapore Criticises Rbis Exchange Rate Policy

S S Tarapore, former deputy governor of the Reserve Bank of India, has questioned the wisdom of the countrys present exchange rate management policy which, he said, had given up the trade weighted real effective exchange rate (REER) in the name of flexibility.

Tarapore who headed the committee on capital account convertibility made this observation while speaking at the Indian Chamber of Commerce (ICC) here yesterday on Asian crisis: Impact on currency convertibility.

RBI is the target of Tarapores criticism which, according to him, had till recently been guided by the loadster of the REER, ie, the trade weighted average nominal exchange rate vis-a-vis major partner countries adjusted for inflation rate differentials.

 

Stating that the real problem does not lie with the large depreciation of the Indian rupee but an appreciation of the trade weighted REER of the domestic currency, Tarapore said the attempts to stem the appreciation by dollar purchase would have created large primary money circulation. The objective of containing the monetary expansion was given precedence over an appropriate exchange rate.

But Tarapore has noted with concern that in the recent period some de-emphasis on REER has not led to prevention of an appreciation of rupee.

His prescription for resisting a fundamental change in exchange rate is to follow a spot-forward swap in the line of buy-sell or the sell-buy variety depending of the type of action sought to be achieved.

Understandbly, RBI policy on exchange rate management has come under close scrutiny from its former deputy governor. According to RBI, a balance has to be struck between the need for exporter-favoured exchange rate and prevention of monetary expansion.

Containment of domestic price increase is also important in this context. There can therefore be no rigid formula governing exchange rate determination, RBI has stated in its 1996-97 annual report . By pursuing this line RBI has given up a clear measure for determining appropriate policy responses, Tarapore said.

He has been consistent on the capital account convertibility with reiteration of the statement that it should be implemented by meeting certain preconditions.

The three-year timeframe for implementation set by the panel on it will have to be extended till the preconditions are fulfilled. This has assumed importance in view of the currency turmoil in South-east Asia.

Preconditions relate to reduction in fiscal deficit, low inflation rate and strengthening of the banking system. Banking system with 10 per cent non-performing assets has become the most vulnerable segment of the economy.

Ratio of short term debt along with portfolio stock as a percentage of forex reserves should not exceed 60 per cent and the present ratio of 75 per cent, according to Tarapore, is a matter of concern.

Along with short-term banking liabilities of $7.75 billion at the end of June 1997 with the consequent rise thereafter coupled with some non-banks short-term liabilities these could well be $ 23 billion or 85 per cent of the forex reserves.

Tarapore said ratio could be indeed around 100 per cent considering that there would be forward liabilities.

To check the tendency of short-term debt to rise he suggested a system where higher the incidence of tax shorter the maturity of trade credit and vice versa.

There should also be a close monitoring of the net forex assets-currency ratio which should not be allowed to fall below 70 per cent, though it would be highly desirable to restore the statutory ratio of 40 per cent which was abrogated in the fifties.