In 1997, the US dollar-Indian rupee exchange rate was stable in the first half of the year. The US dollar traded at slightly below Rs36 until about mid-August. Then, with the Asian economic crisis slowly intensifying, the US dollar gained in strength against the Indian rupee. It does not matter whether it gained more or less strength against the Indian rupee than against other Asian currencies. By 15 January 1998, the US dollar had appreciated to around Rs40.65. On 16 January 1998, the Reserve Bank of India (RBI) announced several measures. One can find them at http://bit.ly/19cZ4Pm.
RBI increased the bank rate from 9% to 11%; it increased the fixed rate repo from 7% to 9% and it increased the cash reserve ratio from 10.0% to 10.5%. Interestingly, it added that the fixed rate reverse repo would be available to primary dealers on a discretionary basis, subject to stipulation of conditions on their operation in the call money market. The measures were explicitly aimed at stabilizing the rupee exchange rate. They worked. Measures taken by the central bank in January 1998 restored stability on the exchange rate front for four months until new developments reintroduced volatility and rupee depreciation.
Faced with a similar situation, RBI announced liquidity tightening measures last week. Further, the incremental increase in interest rates was 200 basis points. The week before the US dollar had traded at over Rs60. Now, the rupee is tenuously stable. As we write this, one US dollar fetches Rs59.41. One newspaper accused RBI of throwing the baby with the bathwater. On Monday morning, we read on the Mint website that there was no method to RBI’s madness (http://bit.ly/1b6xuF4). These are strong words. One must spare a thought to RBI’s dilemmas. The institution is fighting a lonely battle to avoid further humiliation for India. We doubt if the UPA government would really like to see India put in an application to the International Monetary Fund for external funding assistance now even though it has done its best to push India into such a situation. That is what RBI is trying to avoid too, but it is fighting with hands and legs tied and its voice silenced.
In June 1998, Bimal Jalan, the then governor of RBI, speaking about India’s macroeconomic conditions, said that in the previous three years, on an average, India had maintained a GDP growth rate of 6.6%. It had an inflation rate of about 5.7%, one of the lowest in the developing world, and a sustainable current account deficit of 1.4%, he said. External debt to GDP had been reduced from 32.3% in March 1995 to 23.8% in September 1997. The debt service ratio also had been reduced from 26.2% in 1994-95 to an estimated 18.3% in 1997-98. (Source: http://bit.ly/15aLjMV )
India would die to boast of such metrics now. It is not the case. Consider, for instance, the question of external borrowings. The chart on Page 17 of the Financial Stability Report published by RBI in June shows the amount of money raised by Indian companies abroad through bond issuance. Eye-balling the chart, one can estimate that Indian companies raised more than $50 billion in international markets in the last four-plus years. What kind of research or analysis had they done about their own country’s governance, fiscal deficit performance and their export growth prospects and, therefore, what was their outlook for the Indian currency before they fell for the temptation of low interest rates in hard currencies?
Last week, after announcing the liquidity tightening measures, RBI was unable to accept any bids when it tried to sell one-year government treasury bills. Further, it could not mop up liquidity with its sale of government securities in an open market operation on 18 July. The problem is that RBI also has the responsibility of being a debt manager for the government of India. As a debt manager, its job is to raise resources for the government at the lowest possible cost. That objective now clashes with the task of stabilizing the foreign exchange value of the rupee. RBI has held on to its role as the government’s debt manager because the government has the first claim on banking resources through the statutory liquidity ratio. Now, we know what it is to defend the fort without weapons.
One should spare a thought for RBI governor D. Subbarao. He has had the misfortune of having to serve under a government that has been, arguably, the most incompetent and most venal since independence. His predecessors were not so unlucky. Hence, to direct one’s ire at RBI is akin to a cop shooting at an easy target because he is afraid to go after the real criminal.
V. Anantha Nageswaran is the co-founder of Aavishkaar Venture Fund and Takshashila Institution. Comments are welcome at email@example.com. To read V. Anantha Nageswaran’s previous columns, go to www.livemint.com/baretalk