Foreign exchange

If you were at a foreign exchange counter at any Indian airport last week, the quoted rates would have shocked you: a little more than Rs 45 if you were to sell them and more than Rs 53 if you wanted to buy. The spread of nearly 18 per cent between the two prices is shocking; usually it ranges around 5 per cent, which is already higher than what a bank would charge you.

Businessworld
Srikanth Srinivas

But exchange rate volatility also raises a set of issues that may have not mattered six months ago. For one thing, no one is certain how much more the rupee will depreciate, and what that will do to corporate India’s prospects.

Second, the spectre of large capital outflows on top of the $12 billion that foreign institutional investors (FIIs) have already taken out of Indian markets raises questions about the quality of the inflows that led to the huge build-up of reserves until March, even May this year.

Third, while India may have the fourth largest reserves in the world, we are also the fifth largest debtor nation — at $221 billion —according to the World Bank’s Global Development Finance 2008 report. Which brings us to an extreme question: in the event of sudden and large reversals, will our current reserves be enough?

Many like Krishnamurthy take heart from the ‘fierce and coordinated’ intervention by central banks around the world, including the Reserve Bank of India (RBI). They point to the fall in oil and commodity prices (the Indian crude oil basket is about $62 a barrel right now), which implies that the trade deficit that has widened sharply in the past two months, will do better.

Foreign exchange reserves

As the global financial crisis deepens, FIIs may end up taking out more than the $12 billion that they have taken out of our stockmarkets so far.

Corporate India has about $62 billion outstanding in external commercial borrowings (ECBs), starting from 2002. Repayment of about 20-25 per cent of which is estimated to fall due this year. That means another $12-15 billion will likely go out in the next few months.

From July 2006 to March 2008, accretion to foreign exchange reserves grew very rapidly; but from April to June 2008, addition dropped alarmingly. Reserves management then was about managing the demand side of capital flows: discouraging them. Now, it is all about managing the supply side of capital — making sure we have enough.

Under the present situation, if another $60 billion — through a combination of ECB repayments and FII sales — were to be taken out, it would absorb all the rupees released by cutting CRR to 3 per cent (Rs 1,80,000 crore) and an unwinding on the market stabilisation scheme (MSS) (about Rs 1,25,000 crore) that the RBI used to mop up excess liquidity.

Before 1990, foreign exchange reserves accounted for 6-8 per cent of GDP for most countries. Today, they account for close to 30 per cent; East Asian economies built them up as insurance against capital flight, with India following suit. And that is now being flight-tested.

Free Markets ended in 1912

Businessworld
Robert F Bruner
(The author is Dean, Darden Graduate Business School, University of Virginia)


The immense rescue legislation passed by the US Congress marks a historic watershed for the world. Critics from both ends of the political spectrum proclaim the passing of free-market capitalism. If you think the world has had a free-market financial system, think again. A free market avoids the distortions due to regulation; buyers and sellers drive the outcomes; competition is rigorous, and can produce volatile results; there is free entry and exit; investors are free to take risks, harvest any gains and bear any losses.

The free market in finance in the US ended in 1912 with the legislation to create the Federal Reserve System, the central bank. ‘Free market’ does not describe well the financial services industry in the world today: government agencies regulate the entry, exit, and combination of financial institutions; they oversee the transparency of financial reporting and securities underwriting; they influence credit and capital policies of lenders; they manage the money supply through which they drive interest rates and inflation expectations; and they provide the electronic system through which vast quantities of cash are transferred.

Government-sponsored entities such as Fannie Mae and Freddie Mac fuelled the extraordinary expansion of mortgage lending. Since 1978, the US government has managed financial markets to maintain full employment and stimulate economic growth. Similar practices prevail in many other countries.

Government coffers are easy targets for special interest groups seeking to save certain firms, jobs and industries. With the bailout of the US banks, you can be sure the auto and air transport industries will be close behind seeking a safety net. Risk-reduction afforded by regulation is not costless. Do we want an absolutely risk-free society? Absolute risk reduction would choke off innovation, entrepreneurship and growth.

The current crisis is distinguished from previous crises by very great complexity, high speed of news and cash, and very large scale. It is hard to imagine the wreckage that would have occurred by now without the government’s interventions to date. The regulatory innovations roiling the markets do not strike me as the death knell of comparatively free-market capitalism. Or at least, if there is a death to grieve, then it must have happened a long time ago.