RBI slams the brakes on forex market speculation - Views on News from Equitymaster

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RBI slams the brakes on forex market speculation

May 25, 2000

The Reserve Bank of India (RBI) has announced several measures to curb the volatility in the forex markets.

  • A surcharge of 50% of the lending rate on import finance
  • RBI will meet partially or fully the government debt service payments
  • Arrangements to meet the demand for forex for the import of crude are being taken
  • RBI will sell dollars in order to augment supply
  • Overdue export bills, with effect from 26th May, 2000, will be charged interest @ 25% per annum from the date the bill falls due
  • Authorized dealers can approach the RBI directly to meet redemption needs of foreign investors
  • Banks have been advised not to speculate in the markets
The RBI has however stated that it is not targeting any specific level of exchange rates.

The RBIís decisions are aimed at curbing the speculative elements in the market. Imports have been discouraged (as cost of money has been increased), exporters will now have to pay heavily in case they delay the repatriation of sales proceeds and finally banks, which have been speculating in the markets, will come under the RBIís lens. The move is widely anticipated to put an end to the downward slide in the value of the rupee in the near term.

Although the measures were desired in view of the rampant speculation in the markets, the decision to hike the cost of borrowing for imports may not be the best measure. This is mainly due to the fact that investment activity in India is just about picking up. A hike in the cost of capital goods would definitely adversely impact such activity. This could have wider implications for the economy as a lack of investment activity could put the domestic recovery itself in jeopardy.

What does a lower rupee mean for India?
For the public, it could mean higher inflation as the cost of imported goods rises. Even though the size of imports to total consumption is low, it will nevertheless contribute to the rise in inflation rates, which have been on an up trend over the last several weeks.

The fallout on the corporate sector will be mixed. While the exporters will benefit, as they will earn more Rupees for every US Dollar worth of goods they sell, importers would suffer on account of higher Rupee costs. This could hit importers of capital goods (as they usually involve large sums) and raw materials (as costs would rise) in case they lack a forward cover (either in the form of exports or a long US Dollar position in the market).

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