Jamal Mecklai: You can run, but you can't hide

MARKET MANIAC

Heisenberg's Principle of Uncertainty, which, in my view, is the most fundamental of all fundamental laws of physics, states that you cannot simultaneously know both the position and the speed of an electron. This explains why the RBI's efforts over the past several years to control [know] both inflation and the exchange rate, which are both intrinsic properties of the same entity, were doomed to failure over any reasonable length of time.

Granted, they had excellent success over quite a long period, but, as the economy inexorably became more open, they should have recognised the futility of trying to beat a natural law. With the development of our markets not able to keep pace with the development of our economy, foreign inflows, aided and abetted by the weak dollar overseas, first lapped at our shores (2002-03), and then, having tasted the blood of excellent returns, finally broke down the apparently strong boundaries we had erected.

Rather like the Dutch boy with his finger in the dike, the RBI fought these attractive invaders valiantly for several years, preventing the rupee from appreciating. However, since it did not simultaneously make adequate progress on liberalising the markets (and, to be fair, the government did not make adequate progress towards liberalising the economy), the internal pressure of too much money chasing too few goods/services became unbearable.

So, one day""March 21 (nicely coincident with the vernal equinox)""the RBI had to pull its finger from the dike, the rupee exploded through 44, the level the RBI had been protecting, and the rest, as they say, is history.

Of course, we are living that history, and while the rupee appears to have stabilised""very tentatively""in the 40.50 to 41.50 range, the big question is where the rupee goes from here.

Some research we have done shows, quite conclusively, that from 1995 to 2002, the rupee tracked the dollar's global strength quite closely, falling from around 35 to the dollar to its low of 49.05 (about 40 per cent), while the dollar index rose from around 85 to nearly 130 (about 53 per cent). Clearly, even by then, India's integration with the world economy was quite strong. From 2002 onwards, the dollar started to decline overseas""the index has fallen to about 105 today, a drop of about 20 per cent. But""surprise, surprise""the rupee hardly followed suit, rising by merely 10 per cent (49 to 44) till March this year, as the RBI wielded its magic on the dollar to somehow keep it afloat.

Till, of course, the magic ran out, and inflation started to threaten the economy. Heisenberg came into play and the RBI had to choose between its two darlings. Unsurprisingly, they chose inflation and the rupee, freed at last, shot higher, rising nearly another 8 per cent in a matter of a month.

Interestingly, it has not yet fully caught up with the dollar's global weakness""in other words, if the dollar remains weak, the rupee could strengthen further. Of course, if the dollar correction, which began early this week, continues, we could see the rupee slide in response. This is how markets are supposed to work.

Be that as it may, the important lesson from this mini-crisis is that the RBI's well-meaning efforts over the past few years to assist export competitiveness may have actually resulted in creating greater difficulties for exporting companies. If the rupee had been appreciating steadily since 2004, in sympathy with the weak dollar, exporters would likely have been able to absorb the appreciation; instead, this sudden shock has most exporters caught with their pants down and their costings""and their expectations""horribly exposed. And it isn't a pretty sight.

It has pointed up again that you can't fool (or fool with) the market. Once you have opened the door, that's it""the market is in your living room, in your home. And, while it can be the most charming of guests, it can turn quite nasty if you try to threaten, cajole, or push it back into the Pandora's box of globalisation, which, for better or worse, has already been opened.

It seems that both the government and the RBI""driven, to be sure, by the mini-crisis in the money markets""recognise this, and the raft of liberalisation measures announced in the monetary policy last month provided a strong signal that we are back on the path to further liberalisation and capital account convertibility. This signal was, however, confounded by a "doosra" last week in the form of the notification of the [get this] Liberalised Remittance Scheme for Resident Individuals, which prohibits individuals from using the permitted $100,000 as margin to trade in the global market. I found that quite strange. I mean, if I am permitted to take my own rupees and buy up to $100,000 each year, why am I not permitted to do what I like with those dollars, provided I do not break any laws? It doesn't make any sense; in fact, it may even conflict with FEMA, since it is putting restrictions on remittances permitted by the RBI.

I would hope that this was simply a temporary aberration, slipping back as it does to the bad old command and control approach, which is clearly no longer adequate, from a structural standpoint, to manage India's positioning in the globalisation cycle. We need to see more forward movement on liberalisation soonest; else we may have to suffer more market crises, each one of which will be more violent than the last.

You can run, like I said, but you can't hide.