By Jamal Mecklai
The Reserve Bank of India’s (RBI) current “tolerance” of rupee volatility is a welcome change from the policies of its past administrations. To be sure, the volatility has been triggered by grotesque global gyrations, driven in turn by Donald Trump’s apparent efforts to use uncertainty to drive certain business goals. And the RBI has been admirably, I would say, calm in the face of this onslaught. INR (historic) volatility has shot higher from a near all-time low of under 1% to over 6% in a straight line over a period of less than six months, coincidentally reaching a level more or less equal to its 20-year average.
It is, perhaps, a good time for the RBI to drop its oft-articulated exchange rate policy as “we have no target value for USDINR; we only intervene to contain volatility”. It is patently untrue. Volatility describes day-to-day movements in an asset, so if the rupee were to fall (or rise) by, say, 5 paise a day, over a year, the volatility would fall to below 1% while the rupee would be at 98 (or 73); it is hard to believe that the RBI would not intervene if any such pattern were to evolve, even though volatility was well-contained.
To be fair, though, this approach — managing volatility — has been the vogue for global markets since Alan Greenspan at the US Fed introduced the concept of forward guidance in the late 1990s, seemingly unaware that this only succeeded in underwriting risks taken by banks and financial investors — the Greenspan put, as it was called. This enabled rampant risk-taking which resulted in small investors often having to carry the bag while large players ended up smiling in the Hamptons. When Paul Volcker was chairman of the Fed before Greenspan, financial players were a lot more circumspect as a result of which there were fewer outright financial crises. A homily I picked up at my father’s knee around that time was: the central bank should be like God, you know s/he is there but you only see her/him in a crisis.
Unfortunately, with successive Fed chairpersons enjoying the media attention of the post-meeting press conference, this easy hit for financial players remained par for the course, no matter that US equities suffered regular collapses — the dot com bust in 2000, when Greenspan mused about irrational exuberance instead of doing something; the global financial crisis (2008), which was created by rampaging risk-taking by the financial sector and ended when a few banks went bust — of course, nobody went to jail while hundreds of thousands of Americans lost their homes; post-facto Ben Bernancke came up with the solution of providing free money to institutions, but also tightening capital requirements, which seemed to steady things; the next collapse (during the Covid crisis in 2019) was not driven by financial misbehaviour but, again, the solution was free money for the banks and fiscal support (and some debt) for the people, which kept the markets humming with financial sector risk-taking alive and well; and so it goes.
In my view, the real problem is continued guidance by the Fed, which encourages institutional risk-taking, and when things come to grief — as they always do — the real economy has to deal with the consequences. Indeed, there are currently reports that Trump will be pushing to lift some of the capital constraints laid on after the global economic crisis in 2008, which would, again and likely in short order, lead to another episode of “private profits, socialised losses” that capitalism in the US has become.
To be sure, the Indian situation is quite a bit different since (a) our markets are not that open (although the global daily volume of INR transactions has been rising quite rapidly), and (b) the RBI has been quite strict and sound in terms of capital requirements imposed on banks and other financial players, ensuring that the likelihood of a market-driven crisis is quite low.
However, I believe the RBI has been lax in monitoring the bank-customer nexus, under which institutional players have an extremely unfair upper hand in dealing with smaller players. The RBI has, of course, been aware of this for some time — indeed, the Clearing Corporation of India Ltd’s platform, FX-Retail, was set up specifically to address this access gap in the FX market. But, while it is picking up users, the large bulk of small and medium enterprises (SMEs) remain unaware and beholden to their banks for FX prices. The RBI needs to redesign its audit to include the pricing of banks’ FX transactions with customers, particularly SMEs, as also the pricing of structured products, where most companies get unfairly squeezed.
The RBI has just announced a Framework for Formulation of Regulations. Perhaps, this is the right time to roll out a new bank audit process.
The writer is CEO, Mecklai Financial.
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