Banking

Reactive Bank of India

There are three problems in the way the Reserve Bank of India (RBI) has dealt with the ongoing currency crisis. First, the bank has shown a lack of appreciation of the new macroeconomic context. Second, it has used old “control” measures rather than new options and instruments to restore short-term balance. Third, it has taken it upon itself to solve the problem and has not leveraged India’s integration with its regional trade partners.

Even as RBI traces the origins of the crisis to global factors, it has never tried to use the global or regional network of relationships to solve the problem. Put simply, RBI has been reactive, unimaginative and insular.

The result is that the central bank continues to stick to antiquated, short-term, measures aimed at micromanaging markets that are proving to be ineffective. Even the dollar window that it opened for oil companies to provide temporary relief to markets hasn’t been executed properly.

As designed by RBI, the window will provide for sell-buy dollar swaps. This means public sector oil companies will get dollars value dated today and will have to repay the same to RBI after a fixed tenure.

As such, operationally, there is no outright sale of dollars by RBI to oil PSUs. This has been presumably done keeping International Monetary Fund (IMF) guidelines in mind, which require foreign reserves not to be reduced in case of such swap arrangements.

Be that as it may, RBI has not specified the swap tenure. There is no clarity on whether oil PSUs will have to repay the dollars to RBI when the swaps expire or whether they will get rolled over again. In the latter case, the outstanding amount of dollars owed by oil PSUs to RBI will just keep on increasing, which makes a rollover unlikely.

Essentially then, the window will only lead to postponement of around $250-300 million of daily spot dollar demand from the foreign exchange market. In this facility, the spot foreign exchange risk for oil PSUs does not get mitigated, since ultimately they will have to buy dollars from the market. What exactly is such a measure achieving in the end?

The style and substance of support has to change in line with the situations. RBI and the government need to move beyond operational market management and focus on leveraging India’s trade relationships. It is time to look at using the existing trade agreements as a source of propping up the depreciating rupee.

India’s Free Trade Agreements (FTAs) can be used to hedge against the risk of its falling currency. A recent example of this is the convertibility of Australian dollars into Chinese yuan or the renminbi.To take a cue from this example, one of the main FTAs to leverage and benefit from is India’s FTA with the Association of Southeast Asian Nations (Asean). This FTA, considered the world’s largest, aims at opening a market of 1.8 billion consumers to the member countries with a combined output of $2.3 trillion.

Latest trade data shows that Asia accounts for 49% of the trade with India, amounting to about $35 billion. Out of which, Asean accounts for $33 billion or almost 93% of the total trade with Asia. This gives India a window of opportunity to cover almost 50% of the trade through currency convertibility.

At another level, RBI’s currency swaps with South Asian Association for Regional Cooperation (Saarc) countries can be put to good use. In June 2012, RBI set up a $2 billion swap facility for Saarc countries in a bid to bolster regional cooperation in the economic and financial spheres. The swap is offered in dollar, euro or Indian rupee against the domestic currency or domestic currency-denominated government securities of the requesting country.

In this swap arrangement, RBI has taken it upon itself the burden to finance trade among its neighbours without actually having the benefit of calling the shots of a currency swap. As such, RBI must look into redefining the norms of the currency swap along the lines of the Chiang Mai Initiative, which is a multilateral currency swap arrangement among the 10 members of Asean, China (including Hong Kong), Japan, and South Korea.

RBI can make the currency swap with Saarc a tool for exchange rate management making the swap advantageous for transactions only in rupees. For example, by reducing the rate of interest as compared to transacting in the dollar or the euro.With rupee consistently hitting record lows, this may be one of the best time to leverage this opportunity already set out by RBI to consolidate trade with its Saarc members and protect the rupee.

Haseeb A. Drabu is an economist, and writes on monetary and macroeconomic matters from the perspective of policy and practice.

To read Haseeb A. Drabu’s earlier columns, go to www.livemint.com/methodandmanner-

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