Economic Highlights

New Delhi, 23 October 2008

Dollar At Artificial High

RUPEE NEEDS FREE LIBERAL FLOW

By Shivaji Sarkar

The fall of the Rupee to a six-year low, i.e. Rs 49 to a dollar has rung alarm bells. It has not only raised grave concerns about the steps being taken by the central bank, but also the question whether the RBI’s selective intervention has pushed the rupee further down.

In addition, the rupee has been sent tumbling down by the sale of Indian shares by overseas investors, mainly foreign institutional investors (FII). They sold $ 1.7 billion shares and pulled the Sensex down to below 10,000-mark, raising yet another question about the stock market being an economic activity. Now, it is unfortunately being compared with gambling activities!

Still the Union government is seemingly obsessed with the stock market. Even the recent repo (the rate at which RBI lends to the banks) cut is not aimed at boosting bank investors’ confidence, but the “morale” of stock market players. It has pushed the Sensex marginally up. Clearly, a policy change is required for delinking the economy from the stock market. Besides, a credible institution like the RBI should not be made an indirect stock market player.

The 16-year high inflation, which RBI measures failed to control and the worldwide credit crunch triggered by Lehman Brothers’ collapse last month has caused further capital outflows. The FIIs are pulling out fearing greater impending depreciation, which would erode return on investments in the foreign exchange (forex).

Exporters are refraining from repatriating export proceeds. And, in this volatile currency market despite the announcement of hike in interest rates on NRI deposits; the deposits are not coming as per expectations. Worse, the recent CRR cut has instead raised fears of a further rise in inflation as the rupee circulation thrives.

Moreover, the country’s forex market is extremely restricted. The RBI’s claim that the rate is market-determined does not seem to be true. The Indian forex market is a localised phenomenon. The rupee is restricted to national limits. It cannot be sold forward to overseas banks. Each bank or forex dealer has to stay within the prescribed limit imposed by its board, which acts under the guidance of the RBI. This bursts the myth of the rates being market-driven.

If a bank buys $ 1 billion from the market, then as per the RBI stipulation it has to sell the same during the day. This leads to the fall in the dollar price. On the contrary, if the RBI buys the same amount of the dollar from a bank, the latter has to buy the entire sum during the course of the day. This increases the price of the dollar. Thus, it is the RBI and not the market which determines the dollar rate. As per the track records, the RBI has been doing this since 1981. That year alone, when the International Monetary Fund gave a $ 5-billion SDR loan to India, every dollar used to cost Rs 7. However, the fall of the dollar has started since.

Indeed, it looks strange that the dollar has depreciated against all major currencies during the last decade except the rupee. It has been more pronounced since the beginning of the Iraq war. The dollar has depreciated against the Pound by 13 per cent, Singapore $ by 17.55 per cent, Euro by 41.6 per cent, Swiss franc by 30 per cent, Canadian $ by 42 per cent, Australian $ by 30 per cent, and the New Zealand $ by 32 per cent.

On the contrary, the dollar has gained by 4.5 per cent against the rupee. In reality, the rupee is affected more as it has lost heavily against all other currencies. Actual depreciation of the rupee is extremely high, because despite the rupee theoretically being linked to a basket of currencies, the RBI move has made the dollar as the intervening currency.

Unfortunately, it has too many pitfalls. One of it is being witnessed today. The fall of the US economy has affected the Indian market in a way that was never dreamt. The Indian market is far less integrated with the US market but the dollar integration has sent everybody into a tizzy.

It also raises a basic question: whether India, by keeping the dollar high, is actually subsidising the US economy or not. In fact, some of the West Asian nations also do it. They are said to be pressurized by the US government because it remains the largest buyer of oil and the West Asians also happen to be the highest investor in the US. One action against the dollar can not only send their economy into a spin, but it could also lead to political turmoil in the region.

Fortunately, India is not in this kind of a situation. Despite many flaws, its economic fundamentals are strong. The nation also has the capacity to take independent decisions. In such a scenario, economists wonder why the dollar is being kept at an artificial high.

One argument is that there would be loss to the exporters. In this volatile market, export is in a thaw. Besides, the nation despite some export earnings is not dependent on it. A volatile rupee has not helped the exporters. Foreign buyers, in many cases, have tried to use the rupee depreciation to their advantage.  

Today, a free liberalized policy for the rupee is needed. The simplest way could be that the RBI withdraws from the forex market and allows it to settle and find its level. In all likelihood, the chances are that the rupee would appreciably gain, owing to India’s strong economic fundamentals. In such a scenario more foreign capital is expected to flow and take care of the forex reserves.

Once that is achieved, the country would need to gradually delink from the dollar and link up to other strong currencies. Clearly, it would take India out of the blues, not its creation, and set an even growth pace. ---INFA

 (Copyright, India News and Feature Alliance)