Make RBI/MoF’s forex market interventions more transparent

As the forex derivatives case is heating up with each passing day, it would be interesting to see the events as they unfolded during 2007-08, culminating in this huge liability for small and medium enterprises, corporates and banks alike on account of the exotic derivative transactions, which were entered into during that period.

The INR-USD exchange rate, which was consistently between Rs 42 and Rs 49 from 2000 to 2006, became a nightmare for policymakers in a brief period between 2006 and 2008.

The dollar, which was trading above Rs 46 in August, 2006, suddenly depreciated at a breakneck speed and was trading below Rs 41 in August, 2007. The rupee started moving from strength to strength, causing concerns for policy makers and exporters alike.

This also caused the then finance minister, P Chidambaram, to say, “The government is concerned over the rapid appreciation of the rupee against the US dollar and the central bank may have to intervene if there is disorderly movement in the exchange rate.”

The exporters were not far behind in voicing concerns over the precarious situation the rapidly depreciating dollar had caused for them.

“The profitability of exporters has been wiped out and constant appreciation is threatening the competitiveness of our product. If we lose the market, aggressive competitors are just sitting on the fence to occupy the market,” G K Gupta, president of the Federation of Indian Export Organisations (FIEO) said in October 2007.

However, there was worse to come —- the rupee rose further and the dollar fell despite the efforts of the Reserve Bank of India (RBI) to the contrary —- and by December, 2007, it had reached a level of Rs 39.40. In a brief period of 16 months, the dollar had depreciated by over 15% and was threatening to plumb newer depths.

The RBI has a clearly stated policy on the foreign exchange market, as espoused by former RBI governor Bimal Jalan in 2003: “The objective of the exchange rate management has been to ensure that the external value of the rupee is realistic and credible as evidenced by a sustainable current account deficit and manageable foreign exchange situation.

Subject to this predominant objective, the exchange rate policy is guided by the need to reduce excess volatility, prevent the emergence of destabilising speculation activities, help maintain adequate level of reserves, and develop an orderly foreign exchange market.”

The RBI, true to its publicly stated policy, did in its best judgment intervene in the forex markets in an unprecedented manner.

At this time it would be pertinent to note that the INR-USD movement was not particularly in sync with the movements of other similar currencies against the dollar.

Between February 2002 and March 2008, major currencies rose against the dollar in a range of 23-47%. However, in the same period, the rupee rise against the dollar was about one-third as rapid as the euro’s rise of 45% and less than one-half as quick as the average rise of all currencies.

Even weaker currencies with less brighter fundamentals than the rupee had moved up more rapidly than the rupee.

As the dollar fell, other currencies rose more rapidly against it than did the rupee. However, when the dollar rose, the rupee fell more rapidly than all other currencies against the dollar. This situation unfortunately arose out of RBI’s interventions.

What went wrong?

It is very clear that when the dollar was depreciating, the Reserve Bank of India did not allow the rupee to rise against the dollar as rapidly and as much as other currencies did.

The RBI had clearly justifiable reasons to build and keep a substantial forex reserve. India was running a huge trade deficit. With volatile global oil prices, high forex reserves became a strategic need. Also, with the uncertain economic scenario globally, there was a necessity for higher forex reserves to ensure a stable exchange rate for the rupee.

To quote some published figures on the magnitude of the RBI intervention, during the January-June 2007 period, the RBI’s monthly mop-up was in excess of $3 billion.

In July alone, the central bank mopped up 4 times that amount —- a whopping $11.4 billion. Yet the dollar did not rise, but fell even further, to Rs 40.40. Here, the finance minister stepped in to possibly stop the rupee rise. And the result —- between September, 2007 and January, 2008, in just five months, the RBI bought, in spot and forward, an average $13 billion a month. Still the dollar fell and the rupee rose to Rs 39.30 per dollar. By March 2008, the forex reserve had moved close to $300 billion.

From January, 2008 to March, 2008, RBI as well as the Indian oil companies started buying dollars in spot and forward markets, which pushed up the demand and thereby increased their costs.

The rupee started moving southwards. From over Rs 39 to a dollar in January 2008, the rupee moved down to nearly Rs 43 by July 2008. The G7-induced dollar rise of 16% against the euro hit the rupee thereafter. And the RBI completely lost control. By October, 2008, the rupee plunged further to an all-time low — nearly Rs 50 per dollar.

After being hit badly with the rapid depreciation of the USD against the INR, the exporters were already at their wits end. A plethora of analyst forecasts regarding the possibility of USD-INR rate touching 35 in the near future and possibly even 30 in the medium term followed. This led exporters to cover their receivables for periods longer than usual.

It was at this time that the ‘exotic derivatives’ with contract periods of as long as 3 years were introduced into the Indian market. Unfortunately, a lot of these products did not meet the basic guidelines of the RBI itself and Fema. The cardinal rule that a forex contract which increased the risk to the corporate was not permissible under the law was ignored to disastrous consequences for many companies. The total marked to market (MTM) losses to the corporates due to contracts entered in that short period of time shot up to Rs 31,719 crore, as stated by the RBI itself in many submissions.

The questions that beg to be answered then are — Could these losses have been avoided if RBI/ MoF had issued clear-cut statements and directives either directly or indirectly through the banks, which would have prevented a mass signing of derivative contracts? Could the RBI have prevented the mass selling of exotic derivative contracts through setting up appropriate policy measures?

Market interventions are a reality in a country like ours, where we do not have full capital account convertibility. This has happened in the past and will surely happen again in the future.

The RBI (and the MoF) through their well-timed interventions have definitely followed a prudent publicly stated policy.

But there needs to be greater amount of transparency on the part of RBI (and MoF) to prevent mishaps like these from happening. This can help in preventing SMEs and corporate India from becoming collateral damage in case of market interventions.

There should also be appropriate controls to prevent mis-selling of products, like setting up of a body to approve derivative products before they are introduced in the market.

Lastly, it is important that regulatory mechanisms and clear-cut penal guidelines are put in place to ensure that rules are followed not only in letter but also in spirit. After all, that is what banking is all about — TRUST!

The writer is a former president of the Institute of Chartered Accountants of India and an educationist. Views are personal.