Too much stabilisation

Updated: Apr 30 2007, 05:30am hrs
Rupee appreciation is making exporters unhappy. Fears are being expressed, though without much backing, on how industries will close down, workers will lose jobs and Indias current account deficit will rise. So, should the RBI start manipulating the rupee again Every policy has costs and benefits. Let us suppose that until now the benefits of the currency policy that kept the rupee weak were higher than the costs. The policy, then, would be fine. But what if there has been a change in circumstances so that the costs now exceed the benefits Should we continue with an old policy only because it has served us well so far For many years, the RBI was able to sterilise its foreign exchange intervention smoothly. The artificially weak rupee played a role in boosting exports. But today, sterilisation is becoming very costly. It results in higher domestic interest rates, which has already hurt large numbers of individuals and businesses badly.

As long as keeping the rupee weak was a cheap affair, the man on the street did not care. But today, he does, and this should not be dismissed lightly. The Monetary Stabilisation Scheme (MSS) was set up to allow the RBI to sterilise its intervention and prevent inflation that could be a fallout of its attempts to prevent rupee appreciation. But as dollar purchases rise beyond a threshold, only higher interest rates can sell more bonds that mop up liquidity (the cost to the exchequer is only part of the story). Higher rates even than what inflationary conditions might warrant, that is. This is the problem. While lending rates in India, overall, may have gone up in response to the RBIs slew of inflation-fighting measures (such as the recent hikes in the cash reserve ratio and repo rate), it is clear that the rising rates on government bonds have added upward pressure of their own. This being the case, should the ministry of finance let the MSS be used even more extensively so that the RBI can continue to keep the rupee down This is becoming more and more untenable. The costs of the old policy now exceed the benefits.