The Reserve Bank of India (RBI) has sent a very strong signal to the foreign exchange market that it is ready to deploy every tool in the book to defend the rupee if it sees a short-term risk of “accelerated downward spiral in the rupee’s exchange rate”. For good measure, RBI Deputy Governor Subir Gokarn also added that selective intervention in recent days should not be “misconstrued” as the central bank’s inability to deal with the challenge. “We do have instruments in the form of strategic capital controls and the capacity to enhance the supply of dollars in the market and will use them as and when appropriate,” Gokarn added. Indeed, this was a very clear and unambiguous stance taken by RBI, and this is what central banks are supposed to do. Over a fortnight ago, the same deputy governor had appeared to suggest, or at least the market read it as such, that RBI’s capacity to intervene in the market was limited, given the large volumes in the forex market. Second, he had said RBI will intervene only if there was volatility in the rupee’s movement against the dollar. Again, the market read this as a signal that a one-way movement of the rupee, without volatility, was acceptable to RBI. After all, volatility, by definition, is a sharp two-way movement that causes panic among the market players. This somewhat ambiguous communication of RBI had partially caused the sharp depreciation of the rupee, which had threatened to breach the R53 to a dollar mark in the latter half of November. Then everyone began asking, when would it cross the R55 to a dollar mark? This question is still on the minds of market players as well as businesses that have substantial dollar earnings or liabilities. RBI’s latest communication that it could intervene with strategic capital controls if “there is a short-term risk of accelerated downward spiral” will certainly help temporarily ward off speculators waiting on the sidelines to take out the R55 to a dollar level. However, don’t think that these speculators will go away any time soon. They had tasted blood when the rupee breached the first psychological mark of R50 to a dollar and were delighted when it crossed R52, and are now hoping it will breach R55 in the short term. RBI, with its latest communication that it will use strategic capital controls to defend the rupee, is ready for the big fight with these punters, most of whom are operating from outside of India. Even though it should not have been said publicly, there is some truth to the RBI deputy governor’s earlier assertion that the forex market volumes are too big right now for central banks to remain fully in control of. The cardinal rule of central banking is that such truths are not spoken of publicly. If the Federal Reserve or the European Central Bank started speaking the truth about the underlying risks in the global financial markets, there will be nobody left to play in the market! Indeed, the reality is no central bank is fully in control of events in the financial markets, especially in times such as these. The forex market is the most complex of them all. For instance, RBI is hardly in control of over 50% of the daily rupee trading that happens outside India’s jurisdiction. This happens out of Dubai, Singapore and other financial centres in Asia. It is called the non-deliverable forward (NDF) market that functions outside India where foreign banks and other global players are betting on the rupee simply because they see India as a dominant economic story. This trading in the rupee outside India has grown from some $3bn per day in 2007 to $45bn per day this year. It was only $19bn a day until January 2010. The price discovery for the rupee’s exchange rate is substantially happening outside India now. This cannot be avoided because foreigners want to take a bet on the rupee. Some years ago, a big Japanese bank agreed to denominate in rupees the repayment of a yen loan borrowed by a Latin American entity. Our finance ministry protested but could do nothing because the rupee rate was being used outside India’s jurisdiction! The larger point, therefore, is our political class must realise that India is already a global entity. Therefore, the sudden burst of nationalist/protectionist fervour, as displayed in the opposition to FDI in retail, will be highly counter-productive. Globalisation cannot be a half-way house. A fast-growing Indian economy will need net capital inflows of up to 3% of GDP to fill its current account gap for some years. This means India will require an average of about $100bn of net capital inflows in the next decade or so. A good part of this has to be FDI because FII inflows can be fickle in certain years. This year, foreign portfolio investments in the stock markets are next to nothing. In normal years, they are at $20bn-plus levels. Foreign borrowing by corporates, another source of dollar inflows, is also shaky because European banks are shrinking their balance sheets across the board. About 40% of dollar loans accessed by Indian businesses traditionally come through European banks, which are now in trouble. So, today FDI is the only stable source of foreign capital as global corporations are sitting on cash reserves of over $2 trillion, waiting to invest in emerging market assets. They will find buying Indian assets very attractive from a long-term perspective, provided India is open to the idea of FDI in some currently restricted sectors. About 54mn square feet of organised retail space in China is foreign-owned. Just compare that with India’s total organised retail space of just about 30mn square feet. So, is China getting taken over by global MNCs? China has the shrewdness to get foreign capital on its own terms, a form of reverse colonisation, if you please. Our political class is still seeing the ghost of the East India Company! Mr Anna Hazare has also added his weight to this collective paranoia by saying global MNCs will take over India’s retail industry. At this rate, the exchange rate will surely sail past the R55 to a dollar mark, whatever RBI may say to the contrary. The political class cannot have the cake and eat it too. It cannot be xenophobic about foreign investment in retail and yet want the rupee to be strong and stable. The two just won’t go together.
FE
