Last week finance minister P Chidambaram clearly spelt out, for the first time, that the rupee's exchange rate was not in a comfort zone. The sudden surge of capital flows into India following the recent US interest rate cut - more so in the past ten days - has thrown policy makers and the RBI a bit off gear. The exchange rate had moved pretty close to Rs 39 to a dollar mark intra-day even as the Sensex had begun to show signs of flirting with the 20,000 mark. More interestingly, the Sensex surged even more as political uncertainty heightened, clearly indicating that it was ignoring the politics of the day. Just look at how things have changed. The finance minister's statement indicating that the rupee may have appreciated more than required resulted in a fairly sizeable correction in the Sensex - of over 380 points. This was done deliberately to cool the markets. The government today can afford the luxury of seeking such corrections. We may have entered a new phase of talking markets down. From a policy standpoint, both the finance ministry and RBI would want capital inflows to be more predictable. Last fortnight, the finance ministry substantially increased the Market Stabilisation Scheme (MSS) quota of government securities with the RBI from Rs 1,30,000 crore to Rs 2,00,000 crore. This was the first real signal that the government perhaps wanted the RBI to hold the exchange rate closer to Rs 40 by using the enhanced MSS securities, which would help suck in excess liquidity caused by the central bank buying more dollars. Surely, the RBI could buy more dollars in the weeks to come if capital inflows remain of a high order. The finance minister's statement on the exchange rate sets at rest some doubts about the exchange rate policy. The government is now very clear that appreciation of the rupee beyond the present levels could hurt the exporters at large. The commerce secretary last week formally announced the scaling down of the export target. Of course, till sometime ago it was being argued that exchange rate policy cannot be looked at from the exporter's perspective alone. After all, imports far exceed exports and an appreciating currency makes imports cheaper, and helps bring down overall prices. Inflation is the biggest tax on the poor, it was argued. This line of thinking had more currency till sometime ago when the inflation rate was somewhat on the higher side and industrial growth was still robust. However, in the past two months or so, the situation has changed. Industrial growth has shown some signs of slowing across several sectors. And the inflation rate has fallen to below 4%. This has caused a tilt in favour of the argument that the exchange rate must not be allowed to strengthen beyond the present levels. The more important thing now is to pump up exports and industrial growth, both of which are showing signs of decelerating. Small scale exporters have particularly suffered as they don't have a sophisticated hedging mechanism. In fact, the RBI is looking at a system where small exporters can invoice their exports in rupees, rather than dollars. This will protect their earnings and some banks could offer them this product for a fee. Therefore, the new line of thinking is to keep the exchange rate at levels that maintain export competitiveness in the medium term. Azim Premji said something very relevant in this regard. He argued that in spite of the strengthening rupee exporters can indeed protect their margins through higher productivity, but they need time to adjust. The government appears to have understood this logic.
