Volatile arguments

The RBI is again,reportedly,intervening in the rupee-dollar market to prevent rupee appreciation. While the immediate reason for this appears to be the foreign money flowing in for IPOs like Coal Indias,the issue should be looked at in both the contexts of the global currency debate and Indian policy. The last few weeks have seen currency wars heating up across the world,following fears of further quantitative easing by the US. However,if the US dollar is not allowed to depreciate,the rebalancing of the world economy thats hoped to take place through reducing the US deficit will not happen. The US cannot directly weaken its own currency,so its up to other countries to allow the dollar to weaken.

The RBI has stayed away from currency markets for nearly a year,even though smoothing the exchange rate could always have been given as an argument for intervening in the currency market,as it has now. Recently the RBI governor,D. Subbarao,has spoken of how,if capital flows become disruptive,the RBI would intervene. But the costs and benefits need to be carefully considered before intervening. Intervening following pressures to appreciate can make the rupee a one-way bet,as speculators expect slow appreciation. This invites even more capital into the country. Already interest differentials are in favour of capital coming into India. Further US monetary easing will make interest rates here even more attractive. If in addition,there are RBI-encouraged expectations of appreciation,this will invite speculative flows on currency markets. This has happened in India before in 2001-2004. In contrast,when the rupee is more volatile,it prevents such speculative capital from rushing in. By intervening to smooth volatility,the RBI is setting itself up for trouble.

Further,even if the RBI is able to prevent appreciation,today one of the few effective weapons it has to control inflation,is it acting in the interests of a small group of exporters or the general public? Theres a conflict between the objective of inflation control and preventing appreciation. The RBI and government should focus on inflation and stay away from the dangerous game of currency intervention.