Foreign Exchange Stabilisation Fund

Exchange rate conundrum- Why not create a Foreign Exchange Rate Stabilisation Fund  initially with the black Money stashed abroad to salvage the rupee from the volatility and  save the economy from its consequences.   

Currency yo- yo is  common says the PM and adds such fluctuations are bound to happen in a market economy. The currency goes up and down in a market economy and India cannot be an exception to the Global situation.

The rupee has become highly volatile and it has crossed 56 a dollar   despite  the intervention from the Reserve Bank. The stability of the rupee has been a hotly  debated topic for quite some time as the fundamentals of the economy have been very much disturbed due to the failure of the Government in managing the economy with the reforms it badly deserves in the context of deteriorating external economic scenario and domestic economic environment.

The issue of how to tackle the sharp  fall in the exchange rate and save the rupee and the economy  has come to the fore, with the Finance Ministry and the RBI expressing optimism and confidence  that the situation can be managed without the backing of any convincing measures to improve the fundamentals of the economy. The Foreign Exchange Reserves which stood at US $ 309.72 billion in March 2008, peaked at US$ 328.98 billion in August 2011 and came down sharply to US$294.39 billion in March 2012. This has been dwindling since then due to frequent intervention by the Reserve Bank in the forex market to contain the depreciation of the rupee. According to the  Reserve Bank  'The balance of payments (BoP) came under significant stress in Q3 of 2011-12.  Net capital inflows fell short of the current account deficit (CAD), resulting in a substantial drawdown of reserves. A wider CAD, rising external debt, weakening net international investment position (NIIP) and deteriorating vulnerability indicators underscore the need for greater prudence in external sector and demand management policies. While capital inflows have improved in Q4, global uncertainties, moderation in the economic growth of emerging and developing economies (EDEs), which now have a significant share in India’s exports and persistently high oil prices generate downside risks to the  external outlook'. RBI Bulletin May 2012).

In response to the series of measures initiated by the Reserve Bank FII inflows picked up significantly, in both equity and debt, in January and February. While FDI inflows remained broadly stable, the ECB inflows also improved a lot. The rupee  which depreciated  sharply against the US dollar from the last week of August 2011 to mid-December 2011, recovered and stabilised  for some time  as a result of  the  measures undertaken by the Reserve Bank and the government at improving dollar supply in the foreign exchange market as also to curb speculation.  The cumulative impact of these measures considerably reversed the movement of the rupee against the US dollar from the historical low of `54.2 per US dollar on December 15, 2011 to `49.7 per US dollar by end-January 2012. However, the rupee weakened  subsequently and crossed  ` 56 a dollar on  May 23. As per RBI's own admission, the  key external sector vulnerability indicators have been worsening over a period. The reserve cover of imports, the ratio of short-term debt to total external debt, the ratio of foreign exchange reserves to total debt, and the debt service ratio  got deteriorated over a period.

The Current account Deficit which was only 2.3 % of GDP in quarter 3 of 2010-11 crossed 4.3%  of GDP in quater 3 of 2011-12 and  continues to rise  unabated.  As long as the high level of international prices of  oil  remain,  as also the consumption of  oil, which has been on the increase  and the pricing pattern for the same presently adopted  continue to be politically sensitive and economically non viable , the position of  BOP, exchange rate, fiscal deficit and current account deficit etc cannot be expected to show any considerable improvement in the near future. The external environment with the  Greek and   other European  economy in  crisis also does not offer any consolation to expect a favourable position to improve the trade and increase in inflows of foreign exchange. The FDI and FII flows can be augmented only if  the fundamentals of the economy and the  overall confidence in the management of the economy  can be established  through  the  process of reforms in different areas like administration, taxation, legal and infrastructure  development  particularly in the power sector which is unfortunately not taking place.

The  present critical situation merits the consideration of calls for an abnormal solution. In this context, it is ideal to set up a Foreign Exchange Rate Stabilisation Fund, to contain and prevent the frequent volatility of the rupee and its adverse consequences on the economy. The Government's recent  white paper on black money has hinted at an amnesty scheme for assets secretly amassed abroad. These funds can be mobilised under the nomenclature Foreign Exchange Rate Stabilisation Fund and can be maintained with the Reserve Bank on behalf of the Government. It is best and the most opportune time for the Government to finalise the amnesty  scheme expeditiously  though it  may  perhaps involve loss of revenue and forbearance in taking penal measures. Although,  the white paper is silent on the quantum of such money, the amount if permitted to bring in officially, would be huge sum and beyond the imagination of the Govt,  as it may  help to avoid the other routes  like PNs and FDIs now suspected  to  route the black money to India.

To neutralize the impact of purchase/sale of foreign exchange and consequent money supply and liquidity in the market, normally sterilization is done using government securities for sale/purchase. The whole exercise involves a cost and creates an element of uncertainty and speculation in different markets in the financial system. These can be to a great extent minimized if  the foreign  exchange mobilised under the Exchange  Rate Stabilisation Fund is allowed to be retained as such without involving rupee exchange. For the contributor towards this fund, this can facilitate as a deposit account that can be withdrawn on demand of course after running a specified period subject to the terms and conditions prescribed under the amnesty scheme.

The main advantage of such a fund would be that it would attract inflows, eliminate instant rupee supply and the consequent ripple effects. The cost involved in creating such a fund and the disadvantages if any perhaps faced by those who contribute to this fund will more than offset the problems and costs now faced by the economy because of shortage of  foreign exchange and  adverse chain effects. This fund can be utilized for exclusive development of infrastructure requiring foreign exchange.

This solution may initially appear to be irrational but may prove to be a boon in the long run for all stakeholders particularly the government and the economy. The Govt can also keep this fund open to those who have surplus forex resources and are willing to contribute for some incentives.

This fund can be akin to the India Development Fund where deposits were received for a specified period. The contributors to the fund( other than those who bring funds under the amnesty scheme) now being suggested can be compensated by way of interest or some incentive or both in rupee terms. Exchange rate risk at the time of return of the funds on demand or on maturity can be hedged through derivatives. This will also activate and strengthen derivatives market. The funds accumulated can be made available to utilize exclusively in forex for development of infrastructure by way of import of technology, skilled manpower, materials research and development.

The setting up of such a fund, without involving rupee exchange, initially appears to be conceptually difficult but, it cannot be ruled out as impossible. It is like Security Transaction Tax which was initially objected to but has come to stay fetching good revenue to the Government and without inflationary implications as the levies cannot be passed on  to general consumers as happens in the case of VAT and other levies.

The costs involved in developing , maintaining and managing such a fund may turn out to be highly beneficial when compared to the present crisis, costs and risks involved to contain the volatility of the rupee, maintain financial stability, favourable inflationary conditions and the credibility among the international community to continue to attract investments in India.

Dr.T.V.Gopalakrishnan

Consultant, Mumbai.

(views are Personal).

Edited version of this article appeared in The Hindu Business Line Dated 24/05/12. Pl see my blog for a similar idea expressed when the economy was facing the problem of plenty of forex flows.

RBI finally succumbs to market, Govt pressures

May 6, 2012:

While announcing the policy in January 2010, the Governor, Reserve Bank of India, made an observation that “getting out of an expansionary policy is much more difficult than getting into it. It is like a Padma Vyuha in Mahabharatha –you know how to get in but not many people know how to get out.”

It seems the statement equally holds good when the issue of coming out of a contractionary policy comes up when an unfavourable macro-economic environment exists/persists as of late.

The RBI in its credit policy announced on April 17, 2012, gave a surprise by effecting a 50 basis point cut in its repo rate from 8.5 per cent to 8 per cent with immediate effect as against 0.25 per cent expected and speculated by the market.

Consequent to this, the reverse repo rate under the LAF, determined with a spread of 100 basis points below the repo rate, gets calibrated to 7.0 per cent. Similarly, the marginal standing facility (MSF) rate, which has a spread of 100 bps above the repo rate, stands adjusted to 9.0 per cent.

Further, in order to provide greater liquidity cushion, it has also been decided by the RBI to raise the borrowing limit of scheduled commercial banks under the MSF from one per cent to two per cent of their net demand and time liabilities (NDTL).

The market sentiments more than the macro-economic fundamentals seem to have influenced the RBI's credit policy can only be the explanation for such a sharp cut in the repo rate when all the macro economic factors without an exception are opposite to what the RBI would have wanted.

When the fiscal deficit, current account deficit, inflation level particularly consumer price index inflation, exchange rate, international price of oil and all other external and domestic factors which have a bearing on the FDI and FII investment in the economy are not favourable, the only reason for the RBI to have come out with a policy cut is to give the much needed boost to economic growth by improving the sentiments and confidence of the investing community.

Although, according to the RBI, the decision to ease the policy rate has been based on two broad considerations viz; the economy is clearly operating below its post-crisis trend and there is a decline in headline inflation from 9 per cent in January 2010 to below 7 per cent by March 2012 and non-food manufactured products inflation has dropped from a high of 8.4 per cent in November 2011 to 4.7 per cent in March 2012, actually coming below 5 per cent for the first time in two years, the reasons are not very convincing when the RBI itself admits that there is a need to guard against risks of demand-led inflationary pressures re-emerging.

The RBI had taken series of measures to contain inflation, but the inflation numbers have remained high and way ahead of the RBI's comfortable level fixed at 6 per cent.

The need to put up with an inflation at more than 6 per cent is getting an official recognition is the message that one gets from this policy announcement and this has been endorsed by none other than by the Finance Minister when he advised consumers ‘to learn to live with 6-7 per cent inflation' during his address in the annual CII conference held in New Delhi on the April 17, 2012.

The continued high level of inflation and poor growth of GDP are beyond the control of monetary policy measures alone have been well proved over a period and these monetary measures in the absence of supportive fiscal measures have adversely affected the growth trajectory as indicated by the declining trend observed in IIP and GDP growth.

Infrastructure bottlenecks and other supply related constraints also are other major concerns which do not get the required attention from the Government. The policy rates were revised upwards 13 times commencing from January 2010 and the CRR rates which were enhanced twice during 2010 were revised downwards in two instalments in January 2012 and March 2012 to contain inflation and address liquidity issues in the economy.

When the inflationary pressures continue to persist and upside risks are high in the RBI's own admission, the sharp reduction effected in the repo rate purely from a monetary point of view carries no conviction though it carries a message to the Government to initiate action both from the administrative and fiscal front to facilitate investment and production.

It also satisfies the demand of industry and market to reduce the policy rate as if interest element is a major component of the cost of production.

The policy projects GDP growth at 7.3 per cent which is reasonable and achievable despite the constraints.

The deposit growth projected at 16 per cent and non-food credit growth at 17 per cent compared to the past trend are very moderate and banks have to put in special efforts to attract more deposits and reduce the cost of funds.

The present approach of banks in purchasing short term deposits at high costs instead of mobilising deposits needs to undergo a change and banks should go in for long and durable deposits from a clientele consisting of real savers of money. This requires intensified financial and banking inclusion and introduction of customer-friendly savings and fixed deposits products.

The time has come for banks to considerably reduce the net interest margin by adjusting the rate of interest both on deposits and advances and improving drastically the quality of assets. The tendency on the part of banks to depend on borrowed funds particularly from the RBI to run their business has to be curtailed.

The repo facility should not be a perennial source of funds to lend and invest.

The funds management particularly liquidity management of banks needs to be fine tuned and the cost of funds needs to be brought down to improve the NIM and reduce the lending rates. Since the RBI, as is always the case, has come out boldly with the policy change as desired by the market and the Government, it is now the turn of investors, industrialists, bankers and the Government to do their bit to come to the rescue of the economy and meet the aspirations of the people.

What the economy urgently needs, is improved production and low inflation among other things cannot be lost sight of while clamouring for more concessions and reliefs.

(The author is a Consultant and the views expressed are personal).

Dr.T.V.Gopalakrishnan

Keywords: GDP growth, deposit growth, RBI, reverse repo rate, net demand and time liabilities, repo rate

 Dr.T.V.Gopalakrishnan

05 May, 2012 08:58 PM

The measures to contain imports are not adequate. The demand for local purchase of gold and the craze for Gold needs to be contained and intensified.The simple measures the Govt can think of to curtail investment in Gold is to temporarily suspend sale of pure gold by banks and bullion merchants. Introduction of cheque payments or card payments for purchase of Jewellery above Rs 25000 will automatically bring down the demand. Inistence of PAN CARD for all gold purchases above a cut off limit say Rs 25000 will have some favourable impact. The Gold holdings by all tax payers should be reflecting in Tax return from the assessment year 1913-14. These are only administrative measures  and the Govt can easily introduce them without any hesitation.

( This was published in ET dated 5/5/12.)

Who is spending on FMCG's products

Apropos the edit “They are spending” (May 3), your conclusion that consumer sentiment seems to contradict any sense that the India story is stuttering despite the gloom about macroeconomic fundamentals is inconclusive and wrong. The improved performance of the fast-moving consumer goods (FMCG) sector only indicates that the class of people who can afford to buy FMCG products has been on the rise thanks to the widening income gap and increasing purchasing power. This only proves that the demand for such goods is inelastic and that there are people who can afford these goods and much more irrespective of price rise. This does not in any way reflect the economy’s performance in terms of price rise, productivity, employment, poverty levels, infrastructural development, GDP growth, exports, imports and so on. The government’s economic policies help only the rich and the middle class and this has been validated by the better performance of FMCG products. The general theory that increase in commodity prices will reduce demand does not hold true for goods produced by FMCG companies and automobile industries in India since the demand for such goods has always been inelastic thanks to wrong taxation policies and black money.

Dr.T.V.Gopalakrishnan
(This letter appeared in Business Standard dated 4/05/12).

Is the media fair in exposing President's extravaganza

Dr.T.V.Gopalakrishnan
President is welcome to visit any country in the interest of the nation but spending public money one has to be prudent and reasonable. There are millions of people in this country who find it difficult to make both ends meet,live without minimum basic facilities of drinking water, toilet and so on. The president should think of these people when indulging in spending tax payers money which come even from the poorest of the poor. The public anger expreseed through media is only fair and the media of late exposes these extravaganza of the mighty and powerful. This is admirable, appreciable and needs to be encouraged. Public should know how our elected representatives are bad role models.
(This comment was on live in Busines standard dated 4/05/12)