The RBI deputy governor said in his comments to forex dealers that the central banks priority was inflation control; this is absurd when inflation is running at barely 4 per cent. The problem today is export sluggishness, and exchange rate policy should focus on this. A cheaper rupee will even help domestic banks compete more effectively against commercial borrowing overseas, which had become the new corporate game in town.
It is not as if there was no exchange rate policy earlier. Until 1995-96, exports did splendidly and the reserves kept piling up satisfactorily. Now that exports are slack and the real value of the rupee is creeping up in the face of a steady inflow of funds, it is necessary to square the circle: keep giving exporters the advantage of a steadily depreciating rupee while not burdening them and the rest of the economy with a large monetary expansion that pushes up prices and creates the need for further depreciation to keep the real value of the currency under control.
Had the RBI been able to do things its own way it would have probably brought down the rupee more gradually. The RBI has steadfastly maintained that the rupee is market determined and the central bank is there only to even out the fluctuations and step in when speculators move it away from what the RBI deems to be its right value. But all this is not saying much when the foreign exchange market is so narrow, thanks to the prevailing quantitative restrictions. And a band is neither here or there as you can have a wide enough band for it not to be really there.
It is almost axiomatic that the value of the rupee needs to depreciate steadily for Indian exports to be competitive and for there to be a price incentive for exports. If it were not for this consideration, the RBI could well have let the rupee ride up, even in nominal terms, so that imports become cheaper and absorb some of the currency inflow. The RBI has not allowed this to happen, presumably because of the export imperative, and has worked in a halfway house by buying up as many dollars as will keep the nominal rupee-dollar value steady. Domestic exchange rate policy should be geared to setting a proper rate for the rupee, and not be driven by the governments need to borrow. A proper exchange rate policy presupposes fiscal prudence; and the fear of inflation can be addressed in time, if the economy is seen to be getting overheated.
