This makes it difficult to predict the impact of the IMD on the exchange and money markets.

The government went in for IMD because zooming oil prices rapidly burgeoned the nation's oil import bill. The reckoning is that the additional outgo on oil will be about $4.5 billion in 2000-2001. This triggered fears of depletion of foreign currency reserves (already under pressure from foreign portfolio investors who were pulling out of the share markets) and consequent rupee depreciation. There is no knowing, however, if the IMD strategy was thought through. The decision to tap foreign currency deposits seems to have been a knee-jerk reaction to the oil crisis.

The State Bank has announced that it will bring in IMD funds. Consider the following impact scenario. The induction will make little difference to the spot dollar rate, save for a mild depreciation (IMD dollars have been acquired at a cost). But the increased dollar supply will sooner or later diminish the forward dollar premia. Importers will book forward dollars.

The IMD dollars will enter the foreign currency reserves. Assume that the Reserve Bank eschews sterilisation of the counterpart rupees. The increase in liquidity will spill over into additional forward commitments. The rupee will come under pressure: this is precisely the opposite of what is expected from the addition of $5 billion plus to forex reserves. (Note that $4.5 billion of IMD dollars are committed to oil imports; the net addition to reserves is thus small).

However, it is open to the Reserve Bank to sterilise the counterpart liquidity. In the short run, that is till oil import payments for 2000-2001 are tied up, the domestic financial market will be awash with liquidity.

Sterilisation, it would thus seem, is a must. But sterilisation through, say, sale of government securities 25 per cent in excess of planned borrowing (or sale of government securities acquired in the past through the private placement route by the Reserve Bank) will give a fillip to interest rates. This will have a negative impact on investment.

To sum up: bring in IMD funds, don't sterilise the counterpart rupees, and let interest rates soften but then be prepared for renewed pressure on the rupee; or, sterilise the counterpart funds, let interest rates harden (this, in turn, will stabilise the rupee) but then hardening interest rates will dampen investment.

This was precisely the dilemma the policy maker faced before the IMD: interest rates were softened and the rupee weakened; then came the bank rate hike, liquidity tightening measures, and the fiat to bring back foreign currency held abroad in a bid to brake the decline of the rupee.

IMD will not resolve the dilemma of low interest rates weakening the rupee and of hardening interest rates stabilising the rupee to the detriment of investment growth. The policy maker must decide whether it makes sense to hold the rupee stable and let investment wilt.