T N Ninan: Between stools

WEEKEND RUMINATIONS

Barely two weeks ago, you would have had to be offered massive odds in your favour before taking a punt that $4.5 billion of international capital would flow into India's stock market by the first week of October. Well, unprecedented as it is, that is the amount of money that has come in. It is clear that the Indian market "" like many other Asian stock markets "" is seen as a safe haven by global investors. Safe because the financial turmoil roiling through western markets has not ended, and the dollar may therefore fall further. What is the Reserve Bank to do?

Surjit Bhalla's advice, offered on this page a couple of weeks ago, is that it should continue to keep the rupee down, because that is what other Asian central banks are doing for their currencies. Other countries are getting away with doing it, so why shouldn't India? That is certainly one plausible line of action, and one that the government seems to be following, as it has just increased the limit under the market stabilisation scheme by Rs 50,000 crore "" or $12.5 billion. But that extra cushion could be used up in the next three to six months; what then? A further hike in the MSS limit? One could go on with this, if the fiscal situation is comfortable enough to bear the burden of paying the interest on MSS securities "" at a net cost (ie minus the income earned on the dollars that are bought up) of about 5 per cent on Rs 200,000 crore, the total bill works out to less than 0.25 per cent of GDP and the government wastes much more than that on many things that one can list. In any case, goes the argument, that cost must be weighed against the much greater benefit of buoyant exports and what that means in terms of business, jobs and economic momentum. It is an argument that has strong merits, especially if you were to follow the lead of half a dozen countries, set up a sovereign dollar fund, and place it in the hands of competent fund managers who would be expected to get a return that is significantly better than 3 per cent "" thus lowering the cost of MSS even further.

What we do not need is what we have today: a policy that follows this line with half-measures, for it allows a creeping rise of the rupee against the dollar as the RBI effects only a partial sterilisation of inflows. If global investors know that the rupee is going to keep gaining against the dollar in this fashion, they are being given a one-way bet in their currency play and that encourages even more inflows "" thus making the problem worse. If full sterilisation of dollar inflows cannot be done because the inflows are too strong, or because the government caps the MSS as it does not want to keep adding to its fiscal burden, then it is better to go in the opposite direction. Don't do any sterilisation at all; if the inflows continue, let the rupee rise. A sharp increase in the rupee's value will mean more pain to Indian exporters, and more pressure on domestic producers who have to face imported competition, but it would prevent the market being offered a one-way bet. If the rupee climbs high enough (many companies are already betting on the dollar being worth less than Rs 37 in the foreseeable future), and climbs quickly, then investor calculations will change and the inflows will dry up. The market will have found its balance. The additional advantage of this course of action would be that many businesses that are import-dependent will see costs falling (and this includes oil); the counter-inflationary pay-off in the pre-election season may in fact be something to be wished for by the government.

The two policy options have different costs and benefits. Which option you use is a matter of judgment with regard to future inflows, individual bias and an assessment of political sustainability. The RBI and government must decide which of the two options they want. What we cannot afford is the half-way house that we have today.