The regulatory world of innovation has few boundaries. And the way in which India has tackled foreign exchange crises over the years has been quite profound. A forex crisis can be loosely defined as one where the rupee starts depreciating rapidly or when forex reserves slide precipitously. Normally, the two go together, which raises an alarm as unchecked depreciation is always self-fulfilling. When the rupee is expected to fall, exporters hold back their earnings while importers rush to buy larger quantities of forex for future imports, thus exacerbating the position and causing the rupee to fall faster as demand goes beyond supply.
Ever since India’s reforms of 1991-92, the external sector has been liberalized, with even full capital account convertibility being considered at one point. A flexible exchange rate regime runs the risk of volatility, which keeps central banks alert all the time. On its monetary and forex policies, the Reserve Bank of India (RBI) has maintained that it has an array of options that can be used, and hence its approach isn’t straight-jacketed. In the rupee’s context, let’s look at options that have been used in the last three decades or so.
The first course of action has been selling dollars in the spot forex market. This is fairly straightforward, but has limits as all crises are associated with declining reserves. While this money is meant for a rainy day, they may just be less than adequate. The idea of RBI selling dollars works well in the currency market, which is kept guessing how much the central bank is willing to sell at any point of time.
The second tool used is aimed at garnering non-resident Indian (NRI) deposits. It was done in 1998 and 2000 through Resurgent India bonds and India Millennium Deposits, when banks reached out asking NRIs to put in money with attractive interest rates. The forex risk was borne by Indian banks. This is always a useful way for the country to mobilize a good sum of forex, though the challenge is when the debt has to be redeemed. At the time of deposits, the rates tend to be attractive, but once the crisis ends, the same rate cannot be offered on deposit renewals. Therefore, the idea has limitations.
The third option exercised often involves getting oil importing companies to buy dollars directly through a facility extended by a public sector bank. Its advantage is that these deals are not in the open and so the market does not witness a large demand for dollars on this account. It is more of a sentiment cooling exercise.
Another tool involves a directive issued for all exporters to mandatorily bring in their dollars on receipt within a set time period, with allowances made only for balances kept aside that are needed for future imports. This acts against an artificial dollar supply reduction due to exporter hold-backs for profit.
The fifth weapon, once used earlier, is to curb the amount of dollars one can take under the Liberalized Exchange Rate Management System for current account purposes like travel, education, healthcare, etc. The amounts are not large, but it sends out a strong signal.
Sixth, another route used by RBI is to deal in the forward-trade market. Its advantage is that a strong signal is sent while controlling volatility, as RBI conducts transactions where only the net amount gets transacted finally. It has the same power as spot transactions, but without any significant withdrawal of forex from the system.
The seventh tool in India’s armoury is the concept of swaps, which became popular post 2013, when banks collected foreign currency non-resident deposits with a simultaneous swap with RBI, which in effect took on the foreign exchange risk. Hence, it was different from earlier bond and deposit schemes. The same idea has been used again, though without deposits being raised that involve a sale-purchase transaction which provides dollars to banks with a commitment to buy back after, say, 3 years.
All these instruments have been largely direct in nature, with the underlying factors behind demand-supply being managed by the central bank. Of late, RBI has gone in for more policy-oriented approaches and the last three measures announced are in this realm.
First was allowing banks to work in the non-deliverable forwards (NDF) market. This is a largely overseas speculative market which has high potential to influence domestic sentiment on our currency. Here, forward transactions take place without real inflows or outflows, with only price differences settled in dollars. This was a major pain point in the past, as banks did not have access to this segment. By permitting Indian banks to operate here, the rates in this market and in domestic markets have gotten equalized.
Second, more recently, RBI opened up the capital account on NRI deposits (interest rates than can be offered), external commercial borrowings (amounts that can be raised) and foreign portfolio investments (allowed in lower tenure securities), which has the potential to draw in forex over time. Interest in these expanded contours may be limited, but the idea is compelling.
Third, and last, RBI’s permission for foreign trade deals to be settled in rupees is quite novel; as India is a net importer, gains can be made if we pay in rupees for imports. The conditions placed on the use of surpluses could be a dampener for potential transactions, but the idea is innovative and could also be a step towards taking the rupee international in such a delicate situation.
Clearly, RBI has constantly been exploring ways to address our forex troubles and even newer measures shouldn’t surprise us.
No comments:
Post a Comment