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Address the fisc, not the rupee

WITH THE EXCHANGE value of the rupee touching a new low of Rs. 45.85 to a dollar on August 10, the Reserve Bank of India appears to be fast running out of options to stem the slide. The RBI followed up the hike in bank rate to 8 per cent and CRR to 8.50 per cent (in two stages) with measures to suck out the excess liquidity in the economy through repo operations to curb speculation (it has already mopped up some Rs. 18,000 crores within a fortnight). But this did not have much of an impact. Most analyst s, however, see all this as overkill by the RBI, losing sight, in the process, of the goals of growth and asset creation.

Indeed, there was no need for hasty reversal of the process of ushering in a low interest rate regime so assiduously built up by gradually lowering the bank rate from a high of 12 per cent in March 1997 to 8 per cent by March 1999 and further to 7 per ce nt on April 1 this year. The hike in the bank rate to 8 per cent came less than three months after the last cut and after the entire interest rate structure in the economy, including of postal savings, PPF and EPF, had been adjusted downward with some ha rdship to households and pensioners. Now, once again pressure is mounting from all quarters to hike the deposit and lending rates; most banks have raised their prime lending rates. This, coupled with the siphoning off of liquidity, could hurt the nascent industrial recovery after three years of painful slowdown. The recent rupee depreciation has been too modest to need such panic reactions and hasty measures. Moreover, despite the 5-6 per cent fall in the rupee value since April, it continues to rule st eady against the other major international currencies. Incidentally, the US dollar has also appreciated against the other major currencies. Thus, the rupee's weakness is essentially a sign of a strong dollar. Further, the surge in dollar demand could be purely temporary following the rise in imports, both oil and non-oil, in response to the industrial and export turnaround and the bunching of dollar demand from the major importers.

If experience is any guide, monetary measures can, at best, provide a temporary prop to the rupee value. They need to be followed up quickly with measures to strengthen the fundamentals of the real economy for a long-term impact. In this context, the rec ent observation of Prof. Jeffrey D. Sachs, Director, Centre for International Development (CID), appears apt and relevant to the Indian situation. Speaking to Business Line in Kerala, he suggested that Indian policy-makers not worry so much over the unfa vourable rupee/dollar exchange rate. Instead, they should be concerned more about the size of the intractable fiscal deficit. He was of the view that defending the rupee by raising interest rates would have a more direct negative consequence on the econo my than allowing the rupee to find its own level.

The real problem the RBI is confronted with is the persisting divergence between its monetary policy and the fiscal policies of the Government. The country's fiscal policy continues to be out-of-sync with the RBI's monetary policy because of the unbridle d growth in the revenue and fiscal deficits of the Centre and the States, and these being increasingly financed by borrowings. More worrisome is the sharp deterioration in the fiscal situation post-reforms and the consequent diversion of huge funds towar ds interest payments. At a time when the country is dreaming of stepping up GDP growth to 8 per cent, top priority needs to be given to fiscal consolidation. Once that happens, the domestic currency will automatically strengthen.