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KAUTILYA
Beyond the Mumbo-Jumbo
A
simple demand-supply framework for making sense of the rupee's movements
By
Jairam Ramesh
The
rupee is back in the news. On April 1, that is at the beginning of the
financial year 2000-2001, its value stood at Rs 43.6 to the US dollar.
By August 2, the value had weakened to Rs 45.3 to the dollar. It is true
that in relation to the euro and the pound, the rupee has actually gained
but what matters most is its dollar value.
How does
the layperson cut through the esoteric complexity of foreign-exchange
markets? Very simply, a falling rupee means that dollars are in short
supply and in great demand. A rising rupee means the reverse -- an oversupply
of dollars and lukewarm demand. In turn, a rupee is said to fall or weaken
or depreciate when more rupees are needed to buy a dollar. It is said
to rise or strengthen or appreciate when less rupees are needed to buy
a dollar. Most exporters want a weak rupee but a weak rupee also means
costly imports. That is why when the rupee weakens, the RBI tries to control
the supply of the rupee (i.e. its liquidity) by raising its price as reflected
in interest rates and by asking banks to keep money with it to decrease
rupee supply (by hiking the cash reserve ratio).
If there
is a sudden choking in the supply of dollars, the rupee weakens. When
this happens, the RBI steps in and sells dollars from its foreign-exchange
reserves. This increases the supply of dollars in the market. Conversely,
when dollars are pouring in as they did most recently in 1996-97 and 1997-98,
the RBI purchases dollars through a variety of means. In 1996-97, for
instance, RBI's net purchases of US dollars amounted to $7.8 billion (Rs
35,100 crore). On the other hand, since April 1 the RBI has spent over
$1 billion trying to shore up the rupee against the dollar.
Dollars
come in through a variety of means -- through, for instance, foreign institutional
investors (FIIs) into the stock markets, foreign direct investment (FDI)
into greenfield projects or acquisitions, repatriation of export earnings,
deposits by non-resident Indians, assistance from aid institutions and
borrowings by companies.
FIIs, which
move in herds, have invested over $11 billion in Indian stock markets
in the past seven years. But there are periods when they sell more than
they buy. This was what happened in the past two months when net FII sales
were around $485 million. Rising interest rates in the US have made dollar
investments relatively more attractive. Also, Morgan Stanley, one of the
biggest FIIs, increased the weightage for its investments in South Korea
and Taiwan. This has led to a corresponding fall in India's weight.
Exporters
are allowed up to 180 days to bring back their earnings. What happens
is that exporters, anticipating a depreciation, keep their money out till
the very last minute causing pressure on the supply. That is why periodically
the RBI urges them to bring back their earnings as soon as it is realised.
Companies also borrow abroad but keep the money outside for long periods.
This also has led to exhortations by the government.
The demand
for dollars arises from import needs, debt payments and outward remittances.
Oil prices play a crucial role. During April-June 2000, our oil bill was
$3.9 billion compared to $2 billion in the same quarter last year. In
addition, there is a new factor adding to demand -- the Reliance mega-refinery
at Jamnagar and the Mangalore refinery of the Aditya Birla group. From
time to time the RBI funds public-sector crude imports directly to relieve
the pressure on the market.
There are
some noted economists like Surjit Bhalla who believe that if the RBI actually
allows supply and demand to operate, the rupee's volatility will be lower.
This is a point of view. But what is incontrovertible is that the forex
market being very "thin" (a daily turnover of around $3 billion)
the effect of any supply-demand imbalance gets magnified. The growing
integration of this forex market with the money market and the government
securities market has meant closer linkages between monetary policy and
exchange rate policies.
There is
really no "right" value for the rupee. The RBI uses a five-country
real effective exchange rate (reer-5) to judge competitiveness. REER is
the nominal exchange rate adjusted for inflation differentials. REER-5
is a basket of the dollar, mark, pound, yen and franc. Although the reer-5
with 1993-94 as base is reported by the RBI regularly, its utility is
limited in the face of capital mobility. Even so, the latest data show
the rupee being "undervalued" by 0.8 per cent as of June 23.
Since then, the magnitude of undervaluation has increased and is now over
4 per cent. It is interesting to recall here that in the regime of fixed
exchange rates that prevailed till the early 1970s, a plus/minus variation
of 1 per cent (that is, around 45 paise) was considered "normal"
and did not require us to go to the IMF.
The author
is with the Congress party. These are his personal views.
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