The south-east Asian meltdown had posed a severe challenge for the exchange-rate management in 1997-98. The central bank sold about $3.14 billion in the spot market between September 1997 and June 1998 to save the rupee.

RBI categorically states that maintaining a high level of foreign exchange reserves is of paramount importance. "The current foreign exchange reserves position is strong, and the policy objective is to maintain a fairly high level of reserves in relation to current account position, keeping in view uncertain international developments," states the RBI annual report.

The central bank has admitted that the recent developments -- the fall of the Japanese yen and the turmoil in the Russian economy -- have added to the uncertainties, the implications of which are not clear as yet.

The central bank hasidentified four distinct phases of exchange rate movements in 1997-98: April 1997 to August 1997 when calm prevailed in the forex market; September 1997 to mid-January 1998 when speculators took over the market and the RBI announced a tight money policy to block the spillover effect of excess liquidity in the forex market; mid-January 1998 to April 1998 which marked a return of calm; and lastly May 1998 to June 1998 when the foreign exchange market was characterised by considerable uncertainties in India as well as abroad.

"Excess supply conditions in the foreign exchange market, which characterised 1996-97, spilled over into the period August-August 1997," the RBI states.

Alongwith this, sluggish import demand and buoyant capital inflows brought to bear upward pressure on the exchange rate imposing upon the Reserve Bank the need to maintain a delicate balance between the potential loss of external competitiveness and the goal of price stability. "A measure of market surplus is given by the net cumulativepurchases of $5.4 billion by the Reserve Bank during April-August 1997," the RBI adds.

In the second phase, the rupee weakened in the last week of August, partly as a result of a spillover effect of the turbulence in south-east Asian markets. "The demand-supply position in the spot exchange market began to even out and in September the position reversed with merchant purchases falling below the merchant sales for the first time in the year," the RBI states.

As a result, the interbank purchases were higher than the interbank sales, which led to the Reserve Bank selling $978 million in September. In the forward market, excess demand conditions which emerged in August expanded into a mismatch exceeding $2 billion in September as importers rushed for cover and exporters cancelled forward contracts. As the premiums spurted, the RBI sold foreign exchange in the forward market, which took its forward liabilities up by $904 million.

After a brief respite in October, sentiment weakened from November 1997 and thenet forward liabilities of the Reserve Bank rose from $944 as at the end of September 1997 to $1.956 million as at the end of December 1997. Several monetary steps were announced to rein in the rupee like hiking the interest rate on fixed-rate repos, raising the CRR in net demand and time liabilities by 50 basis points, removal of incremental CRR of 10 per cent on NRERA and NR(NR) deposits and suspension of the facility granted to authorised dealers for offering forward contracts on the basis of past performance.

After a brief period of normalcy and rollback of various tight money measures, the rupee headed for a fresh round of attack in May. "From early May, however, uncertainties in market expectations because of domestic and international developments affected the exchange market in the second half of May 1998, even though net sales by the RBI were to the tune of about $754 million almost entirely covered the deficit in the merchant segment of the market in May 1998," the RBI states.

In June, thecentral bank sold about $1.40 billion to shore up the rupee. This was followed by policy initiatives, which included sops to exporters and several restrictions on importers. Banks were also permitted to buy foreign exchange on behalf of their FII clients and FIIs were also allowed to invest in treasury bills.

The foreign exchange market responded positively to the RBI measures and the rupee traded at around 42.39 to 42.53 against dollar in the third week of June.