These episodes of sharp appreciation have been painful and unpopular as the business sector was exposed to sudden destabilising shocks. After the appreciation of the rupee in March-April this year, many exporters complained that what hurt them most was not the appreciation itself but the suddenness with which it came. On the whole, we find that the RBI’s trading on the currency market has not prevented rupee appreciation. What it has given is painful lurches of the exchange rate, instead of a gradual process of adjustment based on ordinary market forces. The RBI’s currency trading has also injected excess rupees in the system, leading to high consumer price inflation which is a major concern for the government. The rising fiscal costs of the “sterilisation” effort through the Monetary Stabilisation Scheme (MSS) that tries to pull out this liquidity is borne by the exchequer. The RBI’s exchange rate policy has impacted the budgets of households and businesses as the RBI has tried to cope with its liquidity injection through hiking the cash reserve ratio of banks. There have been painful and unexpected hikes in interest rates on bank lending and home loan EMIs, unpopular with both the vocal middle class and corporate India. Attempts at capital controls to curb inflows have created instability in stockmarkets.

The most striking example of this was the latest attempt at restrictions on participatory notes. An important side effect of the attempt to prevent rupee appreciation has been that it has made the rupee a one-way bet. One, speculators see India’s huge foreign exchange reserves and know that it is unlikely that the rupee is going to depreciate in any serious way. The sole purpose of the reserves is to defend the currency in case there is a pressure on the rupee to depreciate. Two, speculators see the huge pressure on the rupee to appreciate and the futile attempts by the RBI to prevent this appreciation. When speculators see the difficulties policy-makers are facing, they conclude that it is not possible to keep up the effort to prevent rupee appreciation for very long.

... contd.