Ease the peg

Updated: Jul 27 2007, 05:08am hrs
The RBI is caught in a losing battle, defending an exchange rate of about Rs 40 to the dollar at a time when the latter is under renewed pressure worldwide, and something must be done quickly. As India globalises, the central bank is forced to use ever-thicker wads of rupee notes to manipulate the currencys market price. The dilemma is obvious. If dollar purchases are left unsterilised, as has been done in recent months, they risk igniting inflation. But if they are sterilised through the issuance of bonds, the fiscal burden is heavy. India is staring at an annual bill of Rs 15,000 crore just to keep liquidity conditions stable. Thats enough to build 3,000 km of highways.

We have seen this movie before. All through 2007, until March 15, it looked as if the RBI was stuck on Rs 44 per dollar. But it suddenly gave way, and by April 6, the rupee has risen to about Rs 40 per dollar. This led to distress amongst exporters, who had not prepared for this turbulence. Speculators who had bet on a rupee rise profited handsomely. What is needed now is not just a shift from Rs 40 to about Rs 36 per dollar, but also a new policy framework, instead of lurching from one crisis to the next. The two key elements of this new framework should be transparency and exchange rate flexibility. As of now, the RBIs currency trades are reported only once a month, and that too with a lag of two months. This deprives financial operators in the market of valuable day-to-day information. The RBI should match the disclosure norms that foreign institutional investors (FIIs) operate under, by which daily data on trading comes out with only a days lag. In addition, the RBI should grant transparency to its currency regime or stance. The second issue is exchange rate flexibility. Indias two main stock exchanges, which offer futures and options for equity, should be allowed to start similar platforms for currencies so that millions of households and firms in India can do their own currency risk management. Once risk management tools improve, the stage would be set for more reforms. The RBI needs to move steadily towards ensuring genuine currency flexibilityover, say, a two-year period. At the end of this transition, the Indian rupees exchange value should be determined by market demand and supply, not the RBIs whim.