In difficult times

The Reserve Bank of India has stepped in to provide domestic and foreign currency liquidity to Indian financial markets. RBI signalled to the markets that it would defend the rupee. In an unconventionally transparent statement, RBI said that it would intervene in the rupee-dollar market either directly or through banks. This helped stabilise the fall of the rupee and kept it below Rs 47 to the dollar. Had it not been for this signal to the market, the rupee could have gone into a free fall as the supply of dollars in the market was shrinking rapidly with expectations of further depreciation.

In the past, RBI8217;s stated policy of intervening in the forex market to prevent excess volatility has been misused. RBI would intervene in forex markets day after day on a regular and sustained basis, rather than limit its interventions to times of crisis to prevent very high volatility, such as the crisis currently upon us. In practice, RBI policy was more a policy of preventing appreciation than one of preventing excess volatility. The policy was shrouded in non-transparency and, consequently, RBI lost credibility. So, not only was it correct to step in and stabilise the market with both the liquidity support that has been offered to banks and the support to the rupee, but the statement that was made was an important signal as well. It was a step towards greater transparency.

The US government and the Fed have been stepping in to limit the damage to the real economy through unconventional steps that have been criticised by both the Left and the Right. The lesson from the responses of policy-makers is that the first job of the government and the central bank at a time of crisis should be to worry about the financial stability of the system. There are also other lessons that India needs to learn. The American financial system is suffering as a result of weak financial regulation. Many reports have suggested that financial regulation in India is weak. We should learn lessons from the US and work towards strengthening financial regulation. Until now we have been lucky and have not seen such crises. But it would be wrong to conclude that that was because of the inherent strength of our regulatory structure. It is time for the government to start working towards this goal with RBI, the Securities and Exchange Board of India and the Insurance Regulatory and Development Authority.