This Snake Is A Ladder

WHAT would a Martian see when he looks at planet earth today? Over 150 countries trying to sell their goods and services to one another. Very few countries operate any more as autarkies—self-sufficient and closed economies. The fall of the Malaysian ringgit affects the stock market in Johannesburg. Response times are down to a sliver: make-or-break decisions are taps on a keyboard, zillions of dollars zip around the globe as electronic impulses.

This Tower of competitive Babel is totally devoid of the quality of mercy. If the buzz goes out that someone somewhere has exposed a flank, missiles home in from all around the planet. And a mere scratch can turn swiftly into a full-fledged bloodbath. For, in the marketplace, prophecies have a nasty habit of turning self-fulfilling.

Between November 10 and November 19, the rupee fell from Rs 36.57 to a 21-month low of Rs 37.47.

Of course, the RBI has been intervening and trying to put the brakes on. Said C.Rangarajan, the RBI governor, in a statement: "There is no ground for a further weakening of the rupee. The RBI will not hesitate to intervene to prevent any overshooting." On November 18, the RBI had to sell $250 million (Rs 935 crore), but the rupee halted its downslide only after its second largest fall ever in a day, after the 68-paise fall on September 10, 1995.

Meanwhile, currency speculators betting on the dollar had a great time. With hot adrenaline flowing in the planet-girdling currency trading networks, the forex divisions of banks and institutions smashed the rupee. So would you, if each paisa fall in the rupee-dollar parity translated into Rs 10,000 for every $1-million deal.

The immediate reason for the fall was the State Bank of India buying large amounts of dollars on behalf of its oil company clients. As the RBI kept pumping dollars into the market, the SBI simply grabbed them all. Soon, almost everyone joined the kill, pushing the rupee to Rs 37.48 to a dollar. But the SBI was a mere coincidental catalyst for what happened on November 18. The mayhem had been impending for some time.

No one knows what the correct value—or exchange rate—of a currency is. Market forces decide that. If there are more rupees chasing dollars than there are dollars chasing rupees, the value of the rupee falls against the dollar. And there would be more rupees chasing dollars if currency traders feel that the Indian economy is weakening.

As reported earlier in Outlook (Free Fall, November 10), it was inevitable that the devaluation of currencies throughout Asia during the past month would take its toll on the Indian currency. Over the last three months, currencies in Indonesia and Thailand have been devalued by 33 per cent; Malaysia and the Philippines are down 26 and 28 per cent; even the healthy Singapore dollar has fallen 7 per cent. In contrast, the rupee has remained virtually stable—falling a mere 1.1 per cent. The result is that Indian goods have suddenly become more expensive than goods from say Thailand or Indonesia in the world market.

Importers, as a consequence, are moving away from India. Which is why exporters are crying foul. Says Ramu Deora, president, Federation of Indian Export Organisations: "The very fact that the RBI's pumping in dollars has not helped in arresting the falling rupee is an indicator that the central bank should stop making such small interventions. Let the rupee find its level at par with the other currencies around the globe." But in India, the value of the rupee is often irrationally linked with national pride: the rupee devaluing is a blow to our stature as a nation. Few pay heed to the fact that one of the key reasons for Japan's rise as a great economic power is that in the 1950s and 1960s, it stubbornly kept the yen artificially low against the dollar to boost exports to the West. In recent times, China has been doing exactly the same with its yuan.

Says K.N. Dey, senior vice-president, Mecklai Financial and Commercial Service: "My feeling is that the rupee will settle between Rs 38.50 and Rs 40 to a dollar by year-end." Echoes George Thomas, director, Fiduciary Capital Services: "I think the rupee is due for another correction. By December, if it touches Rs 39 to a dollar, no heavens are going to fall."

But that view is not shared by some sections of Indian industry. According to the PHD Chamber of Commerce and Industry, the depreciation of the rupee, though beneficial to exporters, may not turn out to be a good sign for the economy. Says Binay Kumar, president: "The recent outflow of FII investments from India is a matter of concern for the growth of the economy."

 But that could be a chicken-and-egg problem. FIIs bring in dollars, and if the rupee falls against the dollar, the value of their investments go down. So at the first hint of a coming devaluation, FIIs usually sell their holdings and convert them back into dollars. Then they wait for the currency to settle at its new lower rate, and bring the dollars back in since now they can pick up larger amounts of shares with the higher dollar. Of course, self-fulfilling prophecies run rampant here. FIIs pulling out money from a country leads to greater suspicion about the health of that economy and more pressure on that currency.

The crucial point, though, is: how long will bureaucrats and the RBI manage to hold the rupee against global market forces?

Says Surjeet S. Bhalla, president, Oxus Research and Investments: "The worst policy that any country could follow is to have a stable, managed, overvalued exchange rate." Which is what he feels India is currently doing. A 20 per cent fall in the value of the rupee—to say Rs 42 to a dollar—is what will make India competitive, he says.

Another argument that the mandarins at the finance ministry dole out regularly is that to keep the rupee under strict control is to prevent the Indian economy from becoming vulnerable to international fluctuations—like what happened across Southeast Asia. But to say that India is not integrated with the world economy, says Bhalla, "is to live in a cuckoo world." Emphasises Lester Pereira, director (treasury), Barclays Bank: "The current run is a fallout of three factors: the Southeast Asian crisis, the political uncertainty, and the reduced FII inflows."

True. When the currencies fell in Southeast Asia, Dalal Street shook with fear, and fell sharply. "How long," asks Bhalla, "before we are forced to devalue? Six months? One year?" And as regards industry's reaction that devaluation is not good for the economy: "Everybody's pursuing self-interest. But policy-makers should pursue collective self-interest. " Besides, bankers feel that the basic strength of the Indian economy is suspect. The $30-billion figure for the country's forex reserves does not take into account the forex outflow that the RBI will incur on forward currency contracts, that is, how many dollars it has committed to sell some months in the future.

 For instance, if the central bank had sold $1 billion in July on forward contract for December, the reserves in December should be so much lower. Says a forex dealer of a foreign bank: "This is making us quite nervous. We estimate a sum of around $3 billion that the RBI might have contracted in forward commitments." This is in addition to the $500 million that the bank has used to prop up the rupee during the last few months.

His point could be valid. Discounting gold and the special drawing rights (SDRs)—money that India can draw from the IMF when it wants to—the forex reserves should be around $26 billion. A $3-billion forward commitment by the RBI notionally depletes the reserves to $23 billion. The FIIs have contributed over $9 billion, which, theoretically, can be repatriated any day. "This would leave India's forex reserves at around $15 billion," says the dealer.

This is, of course, the worst-case scenario, since it assumes that no new foreign money flows in, and all FII money flows out. But this sort of thing did happen very recently: in Thailand and Indonesia, for example. The forex market is perhaps the largest market in the world: the value of transactions settled globally each day has risen 1,200 times, from $1 billion in 1974 to $1.2 trillion today. In this market, the RBI with its $20-billion back-up would be small fry.

Says Bhalla: "Every central bank would like to have a gradual depreciation." Mostly, it's not possible. "But in India, the RBI has a 60:40 chance of a soft landing." Why? "It is the only player, the only bully." But is it good for the economy?