The forwards, too, have been relatively calm with virtually no movement upto 6 months; and 1 year forwards have fallen by about 5 paise. Interestingly, the offshore market has been a bit more alive with the 1 year forward falling by over 10 paise since the announcement. The recommendation on a new, and clearly defined, exchange rate policy - specifically, that RBI should set an Exchange Rate Monitoring Band of +/- 5% about the real effective exchange rate (REER), outside which they should ordinarily intervene, seems like an extremely sound idea. The 10 per cent fluctuation band will also provide additional shock absorption capacity. However, we believe that RBI's intervention in addition to preventing a fall-out of the range should also be aimed at imparting some amount of volatility to the rupee market. The chart shows how the actual (nominal) value of the rupee has fared compared to our measure of the REER - generated nominal exchange rate from April 1993 to date. In our model for the REER, we made the
following assumptions: (a) India's exports are 80 per cent in dollars and 20 per cent in European currencies (for which the DEM is a surrogate), (b) For Indian inflation, we have used the provisional/provisional WPI (c) We have assumed competing inflation at 4 per cent from April 1993 to December 1994, 3.5 per cent to December 1995 and 3 per cent after that, and (d) all figures are monthly averages. From the chart, it is clear that RBI is not currently following any policy that is linked to the REER. While different assumptions would affect the exact output of the REER, it is impossible to see any correlation between rupee movements and any REER formula. IThe REER-derived rate and the nominal rate have danced a somewhat unconnected tune over the past year or so, and have once again diverged quite dramatically. Currently (May 1997), the REER-derived rate - at 38.10 - is some 6 per cent higher than the nominal rate. No wonder then that RBI has been more or less continuously supporting the dollar.
If the Tarapore committee's exchange rate monitoring band were in operation today, its limits would be 40.00 and 36.20 . The rupee is already outside that band. Thus, it is time for action. In our view, RBI should immediately implement this as exchange rate policy.
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(Edited version of Mecklai Market Report, June 6, 1997)