The measures announced by the Reserve Bank of India on Monday evening, aimed at restricting credit to banks and curbing speculation in the foreign currency markets, reflect the central bank’s growing helplessness in the face of the rupee’s free fall against the dollar. Since the beginning of June, the rupee has lost 5.51 per cent. On July 8, it touched an all-time low of 61.21/$. More conventional RBI intervention — selling dollars, usually through public sector banks — has had temporary results, with the rupee stabilising for a short while only to resume its downward path. Besides, the extent of central bank intervention is constrained by the availability of dollars in its hands. Drawing down forex reserves to bolster the rupee is never a healthy option and obviously cannot be continued indefinitely. That explains why the RBI chose on Monday to target liquidity in the banking system rather than the exchange rates directly. The measures announced include a Rs.12,000 crore open market sale of bonds, fixing a lower borrowing limit for banks and raising the interest rate on the marginal standing facility (MSF). The last is an emergency funding option available to banks from the RBI, with its interest rate aligned to the repo rate. The new rate, 10.25 per cent, is 3 percentage points above the repo rate; and, despite denials from the Finance Minister, might well portend a tighter than anticipated monetary policy statement two weeks from now.
Concerns over the rupee’s sharp decline have dominated recent macroeconomic policy discourse in other ways too. The financial markets’ sharp reaction to the reported tapering off of the ultrasoft monetary policies of the U.S. Federal Reserve might be an overreaction but it has clearly exposed the external economy’s vulnerabilities, especially in the context of the large current account deficit. Exports are still to pick up and the recent fall in gold imports will be offset by the higher petroleum import bill. Unfortunately, India does not seem to be pursuing any option other than continuing to woo portfolio flows and encouraging corporate houses to continue borrowing from abroad, at least in the short term. The rupee’s fall has shown the pitfalls of these two policies. In June, there has been a big sell-off in India’s equity and debt markets and this has been in tandem with the fall in the rupee. Indian companies which were encouraged to borrow abroad are now saddled with substantially higher repayment obligations. Of the medium-term strategies discussed, the flotation of a quasi-sovereign bond issue to tap non-resident Indians needs to be pursued with circumspection. There are a number of hidden costs, as past bond issues show, besides regulatory hurdles.