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Towards stable exchange rates

Recent movements in the rupee-dollar exchange rates have kindled a debate on the exchange rate policy being pursued in the country. Last week the rupee, which has been on a moderate appreciating trend, touched an eight-year high closing below Rs.43 a dollar. This time, however, it is not so much the costlier rupee that is in focus as the policy stance that made it possible. There are, to be sure, conventional explanations for the rupee's strengths: the dollar has been drifting lower in relation to other major currencies and the dollar inflows continue unabated in India. What is significantly different this time is that the Reserve Bank of India has not intervened aggressively enough to stem the rupee's rise. The issue has become particularly important in the context of inflation. Exchange rate policy can influence the prices of goods and services. An appreciating rupee makes exports less competitive but will lower the import bill. A stronger rupee will help in containing demand-led price pressures in the domestic economy. Wherever feasible, large-scale imports of goods can be resorted to for keeping domestic prices under check. The RBI has often had to walk the tight rope in trying to reconcile the conflicting interests of exporters and importers.

According to its critics, the Reserve Bank has not dovetailed its exchange rate policy with the larger goals of monetary policy. While intervening to stem a rupee-rise, it mops up dollars by injecting substantial liquidity in the domestic market in the first instance. At the second stage, the RBI relies on open market operations to sterilise rupees. Since too much money comes into the system, driving up the prices, the central bank's action on the exchange rate front could, at best, be seen as a roundabout way of reinforcing the key monetary objective of price stability at all costs. At this juncture letting the rupee appreciate without intervention would seem to be the better course. According to that viewpoint, the RBI could in fact have avoided the recent strong, interest rate-boosting monetary package by relying on the exchange rate policy. Such a criticism misses the point that the exchange rate policy has an impact only on a relatively small, though growing, segment of the economy. Secondly, the exports of manufactured goods, which are generally labour intensive, are most likely to be hit in the case of a rupee-appreciation. Latest figures show that the merchandise trade deficit has been increasing. The fact that the balance of payments is in surplus does not in any way reduce the emphasis on traditional measures to boost exports. A stable exchange rate regime is what is needed even in these times.

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