Though belated, the government and the Reserve Bank of India have come out strongly in support of rupee that is rapidly declining in relation to the dollar. The new measures, both administrative and policy, fall into three broad categories. One, the rules governing overseas investment have been relaxed in certain cases so as to increase the supply of dollars in the domestic market and thereby correct its demand-supply imbalance. The ceiling on debt instruments by foreign institutional investors and the interest cap on external commercial borrowings have been raised. The lock-in period for overseas investors in infrastructure bonds has been reduced. Two, in a surprise move — on the day before the credit policy review last week — the RBI clamped down on forward trading in foreign exchange. The avowed objective is to curb the rampant speculation which, in its view, weakens the rupee further. In the third category are the new incentives provided to non-resident Indians to invest more with banks in India. These are significant in themselves and they need to be evaluated in a larger context and over a longer time-frame than in the immediate term.
It is fairly clear, however, that the rationale for almost all these measures is traceable to the rupee's sharp decline and the imperative of arresting it. Absent this justification, the case for introducing many of them at this juncture becomes weak. For instance, given the RBI's concerns over accumulation of short-term external debt, there is no reason for facilitating larger external borrowings by companies. Now, with the foreign institutional investors getting a greater access to the debt markets, including the gilts and corporate bond market, the external economy will be vulnerable to foreign capital flows. The RBI might have succeeded, at least temporarily, in halting the rupee's decline by sending out strong messages to currency speculators — as, for instance, by disallowing the rebooking of cancelled forward contracts in foreign exchange. But clearly these measures are in the realm of micro-management and should go once the perceived threat to the rupee recedes. The deregulation of interest rates on non-resident bank accounts cannot be justified except in the narrow context of encouraging overseas Indian investment at all costs. Past experience suggests that these deposits can exit just as easily as they enter. Besides, with the prevailing low dollar interest rates, there is tremendous scope for arbitrage with minimal exchange rate risk to the Indian expatriate. Neither individual banks nor the macroeconomy stands to gain by mobilising such funds.