Rupee vs Doller

7/31/2019 Rupee vs Doller

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May 23, 2012:

The rupee has become highly volatile and it has crossed 56 a dollar despite the

intervention from the Reserve Bank. The stability of the rupee has been a hotly

debated topic for quite some time as the fundamentals of the economy have

been very much disturbed due to the failure of the Government in managingthe economy with the reforms it badly deserves in the context of deteriorating

external economic scenario and domestic economic environment.

The issue of how to tackle the sharp fall in the exchange rate and save the

rupee and the economy has come to the fore, with the Finance Ministry and

the RBI expressing optimism and confidence that the situation can be managed

without the backing of any convincing measures to improve the fundamentals

of the economy. The Foreign Exchange Reserves which stood at US $ 309.72

billion in March 2008, peaked at US$ 328.98 billion in August 2011 and camedown sharply to US$294.39 billion in March 2012. This has been dwindling

since then due to frequent intervention by the Reserve Bank in the forex

market to contain the depreciation of the rupee. According to the Reserve Bank

'The balance of payments (BoP) came under significant stress in Q3 of 2011-

12. Net capital inflows fell short of the current account deficit (CAD), resulting

in a substantial drawdown of reserves. A wider CAD, rising external debt,

weakening net international investment position (NIIP) and deteriorating

vulnerability indicators underscore the need for greater prudence in external

sector and demand management policies. While capital inflows have improved

in Q4, global uncertainties, moderation in the economic growth of emerging

and developing economies (EDEs), which now have a significant share inIndias exports and persistently high oil prices generate downside risks to the

external outlook'. RBI Bulletin May 2012).

In response to the series of measures initiated by the Reserve Bank FII inflows

picked up significantly, in both equity and debt, in January and February. While

FDI inflows remained broadly stable, the ECB inflows also improved a lot. The

rupee which depreciated sharply against the US dollar from the last week of

August 2011 to mid-December 2011, recovered and stabilised for some time as

a result of the measures undertaken by the Reserve Bank and the governmentat improving dollar supply in the foreign exchange market as also to curb

speculation. The cumulative impact of these measures considerably reversed

the movement of the rupee against the US dollar from the historical low of

`54.2 per US dollar on December 15, 2011 to `49.7 per US dollar by end-

January 2012. However, the rupee weakened subsequently and crossed 56 a

dollar on May 23. As per RBI's own admission, the key external sector


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vulnerability indicators have been worsening over a period. The reserve cover

of imports, the ratio of short-term debt to total external debt, the ratio of

foreign exchange reserves to total debt, and the debt service ratio got

deteriorated over a period.

The Current account Deficit which was only 2.3 % of GDP in quarter 3 of 2010-

11 crossed 4.3% of GDP in quater 3 of 2011-12 and continues to rise unabated.

As long as the high level of international prices of oil remain, as also the

consumption of oil, which has been on the increase and the pricing pattern for

the same presently adopted continue to be politically sensitive and

economically non viable , the position of BOP, exchange rate, fiscal deficit and

current account deficit etc cannot be expected to show any considerable

improvement in the near future. The external environment with the Greek and

other European economy in crisis also does not offer any consolation to expect

a favourable position to improve the trade and increase in inflows of foreignexchange. The FDI and FII flows can be augmented only if the fundamentals of

the economy and the overall confidence in the management of the economy

can be established through the process of reforms in different areas like

administration, taxation, legal and infrastructure development particularly in

the power sector which is unfortunately not taking place.

The present critical situation merits the consideration of calls for an abnormal

solution. In this context, it is ideal to set up a Foreign Exchange Rate

Stabilisation Fund, to contain and prevent the frequent volatility of the rupeeand its adverse consequences on the economy. The Government's recent white

paper on black money has hinted at an amnesty scheme for assets secretly

amassed abroad. These funds can be mobilised under the nomenclature

Foreign Exchange Rate Stabilisation Fund and can be maintained with the

Reserve Bank on behalf of the Government. It is best and the most opportune

time for the Government to finalise the amnesty scheme expeditiously though

it may perhaps involve loss of revenue and forbearance in taking penal

measures. Although, the white paper is silent on the quantum of such money,

the amount if permitted to bring in officially, would be huge sum and beyond

the imagination of the Govt, as it may help to avoid the other routes like PNs

and FDIs now suspected to route the black money to India.

To neutralize the impact of purchase/sale of foreign exchange and consequent

money supply and liquidity in the market, normally sterilization is done using

government securities for sale/purchase. The whole exercise involves a cost

and creates an element of uncertainty and speculation in different markets in


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the financial system. These can be to a great extent minimized if the foreign

exchange mobilised under the Exchange Rate Stabilisation Fund is allowed to

be retained as such without involving rupee exchange. For the contributor

towards this fund, this can facilitate as a deposit account that can be

withdrawn on demand of course after running a specified period subject to the

terms and conditions prescribed under the amnesty scheme.

The main advantage of such a fund would be that it would attract inflows,

eliminate instant rupee supply and the consequent ripple effects. The cost

involved in creating such a fund and the disadvantages if any perhaps faced by

those who contribute to this fund will more than offset the problems and costs

now faced by the economy because of shortage of foreign exchange and

adverse chain effects. This fund can be utilized for exclusive development of

infrastructure requiring foreign exchange.

This solution may initially appear to be irrational but may prove to be a boon in

the long run for all stakeholders particularly the government and the economy.

The Govt can also keep this fund open to those who have surplus forex

resources and are willing to contribute for some incentives.

This fund can be akin to the India Development Fund where deposits were

received for a specified period. The contributors to the fund( other than those

who bring funds under the amnesty scheme) now being suggested can becompensated by way of interest or some incentive or both in rupee terms.

Exchange rate risk at the time of return of the funds on demand or on maturity

can be hedged through derivatives. This will also activate and strengthen

derivatives market. The funds accumulated can be made available to utilize

exclusively in forex for development of infrastructure by way of import of

technology, skilled manpower, materials research and development.

The setting up of such a fund, without involving rupee exchange, initially

appears to be conceptually difficult but, it cannot be ruled out as impossible. Itis like Security Transaction Tax which was initially objected to but has come to

stay fetching good revenue to the Government and without inflationary

implications as the levies cannot be passed on to general consumers as

happens in the case of VAT and other levies.


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The costs involved in developing , maintaining and managing such a fund may

turn out to be highly beneficial when compared to the present crisis, costs and

risks involved to contain the volatility of the rupee, maintain financial stability,

favourable inflationary conditions and the credibility among the international

community to continue to attract investments in India.

(The author is a Mumbai-based consultant)

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Rupee vs Doller