With the forex reserves at a record high and the dollar-rupee ratio at a peak, it is time to impart more dynamism and flexibility to the exchange rate policy instead of merely copying what the US and the Eurozone are doing in their own interest, says T. C. A. Ramanujan."It is war. It is ugly; the consequences could prove highly destructive to the global economy. It is one fought over currency values with the $1.2 trillion a day global foreign exchange markets. In short, it is a war of competitive devaluations."
FOR the first time in several years, the rupee has appreciated against the dollar, forcing the Reserve Bank of India to rethink its foreign exchange policy. Exporters are scurrying for cover. Can they shift their accounts and exports to the Eurozone? It is tempting. But this is easier thought of than done. More than 85 per cent of India's trade is in dollars.
The euro is not a stable currency at all. At the time of its birth in January 1999, the euro-dollar parity was 1:1.18. It plummeted to 1:0.8225 in October 2000. Now, it is practically back to its original valuation at birth, partly due to the interest rate cut by the European Central Bank.
Till 1971, the rupee was practically tagged to the pound sterling. With the weakening of the pound sterling, there was a misalignment of the rupee against other currencies. In 1975, the rupee was pegged to a basket of currencies of India's major trading partners. When export promotion became the objective in the 1980s, the exchange rate came to be used as a policy instrument to achieve a sustainable current account deficit to obtain improvements in the price competitiveness of exports. This led to a continuous downward adjustment in the external value of the rupee. In the aftermath of the first Gulf War, there were sharp downward exchange rate adjustments in July 1991. As the former RBI Governor, Dr C. Rangarajan, pointed out, the depreciation of the rupee was an integral part of an overall structural stabilisation programme to reform India's external sector policies. On the basis of the Report of the High Level Committee on Balance of Payments, India moved towards a market-determined exchange rate system in August 1991.
Partial convertibility of the rupee was introduced in March 1992 requiring 40 per cent of current receipts to be surrendered to the RBI at the official exchange rate, leaving the balance 60 per cent to be converted at the market rate. The difference between the two rates was around 17 per cent and this was criticised as amounting to an implicit tax on exports, leading to distortion in efficient allocation of resources.
There was a smooth transition to a unified exchange rate system from March 1993. The RBI explained, "The objective of the exchange rate management has been to ensure that the external value of the rupee is realistic and credible as evidenced by a sustainable current account deficit and manageable foreign exchange situation.
Subject to this predominant objective, the exchange rate policy is guided by the need to reduce excess volatility, prevent the emergence of destabilising speculation activities, help maintain adequate level of reserves, and develop an orderly foreign exchange market."
To prevent volatility and to supplement normal capital flows, Resurgent India Bonds and India Millennium Deposits were floated. The RBI is actively engaged in purchasing dollars to lend stability to the market-determined exchange rate. The foreign exchange reserves have gone up to $80 billion. The increase in reserves is attributed partly to changes in valuation in the currency and its composition.
Critics are not wanting to point an accusing finger at the RBI for not caring to safeguard the quantum of the reserves. Should we or should we not switch over to the euro in part, and if so, should it be done in the open and at what speed? Luckily for the RBI, the IMF has patted the way the reserves have been managed as being compatible with the best international practices.
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