After two months, the rupee has started depreciating again. The 100 per cent swap arrangement of the Reserve Bank of India (RBI) providing dollars against rupees to oil marketing companies (OMCs) is being phased out.

According to press reports, OMCs are now buying around 40 per cent of their dollar requirements for the import of oil from the market, creating pressures that were absent earlier.

Their total monthly demand is estimated to be $8 billion with the daily average purchase being around $300-400 million.

Equally important for the current exchange rate situation is the rupee-dollar swap that the RBI has with commercial banks against fresh accretions to the Foreign Currency Non-Resident (FCNR) deposits and their borrowings in the international capital markets. (Under this, the RBI sells rupees for dollars, to be reversed at a later date.)

The swap arrangements are not without their side effects. In the case of OMCs the question arises as to what would happen when it is time for reversal of the transaction.

To the extent that they have export proceeds, the problem will be somewhat mitigated.

According to whatever indirect evidence is available, the OMCs’ performance is not noteworthy.

India’s petroleum exports amounted to around $60 billion in 2012-13; of this, Reliance Industries alone accounted for $44 billion.

The very size of the daily purchase of US dollars by OMCs is a pointer to their low forex inflows through exports.

We don’t know how much has to be swapped back by OMCs and when. There is no doubt it will be substantial going by the daily transactions.

When the time comes to pay back the dollars by buying in the market, it will aggravate the depreciation trend, other things remaining the same. Will the RBI be forced to roll over the swaps?

The RBI will do well to terminate the arrangement completely by the end of the month as planned; that would conserve its reserves.

The swap is only exchanging current troubles for future ones.

Swaps with banks

The other arrangement for the RBI to swap rupees for dollars with banks has its own side effects. In the first place, it implies that the forex normally available to the market is withdrawn, thus decreasing the supply. It has an adverse effect on the Indian currency. However, it adds to the reserves of the bank.

Secondly, the swap injects liquidity into the system and increases money supply. The RBI can stop engaging in debt buybacks from the banks till the swap arrangement is terminated. The swaps for FCNR deposits are now for those with a minimum tenure of three years.

To that extent the pressure on the banks to return the dollars to the central bank is deferred to around three years or more.

To modify John Maynard Keynes, in the medium run we are all dead, and banks or the RBI for that matter need not worry in the immediate future.

But, unlike in the case of OMCs, there is a need to continue with the arrangement, say, till the end of the financial year in order to augment reserves. As on November 1, 2013 the foreign currency assets (FCA) of the RBI amounted to $252.6 billion.

The RBI should aim at raising the level to $300 billion by March end. It would mean an average weekly accretion of $2.5 billion. This is not unrealistic considering the progress of the swap scheme so far. The swaps could be phased out in a calibrated manner to ensure an additional supply of forex to the market.

The RBI should drop the remaining restrictions on interest rate and tenure on the swap for FCNR deposits. It will make one- and two-year deposits also eligible. The bank should not be inhibited by memories of the Gulf crisis when there was a massive withdrawal of NRI deposits and, at one stage, a ceiling was prescribed on the amount that could be taken out on a single day. Those difficult circumstances do not obtain now. There should not be any undue concern about arbitrage, which is a fact of life.

The basic question is whether we can manage it. Carry trade has been seen in the past, especially in the context of the yield differences between India and the West/Japan. The RBI could manage the situation.

Immunity scheme

One additional measure I would like to suggest for strengthening the rupee is adoption of the foreign exchange (immunities) scheme of 1991, announced during the Gulf crisis. The source of funds, purpose and nature of remittances were then not subject to scrutiny under the exchange control regulations and direct tax laws.

The only reported misuse of the scheme was conversion of the non-convertible rupee funds, particularly with reference to the special trade arrangement with the erstwhile Soviet Union. Timely action was taken by the RBI to plug the loophole to ensure that only remittances in free foreign exchange were eligible.

The amount received under the scheme was $766.0 million from October 1, 1991 to February 10, 1992. It may seem small at this point of time but it provided a lifeline to the country then. It compared well with the NRI subscription of $1,085 million to India Development Bonds, carrying interest rates of 9.5 per cent for dollars and 13.25 per cent for pound sterling.

The response is likely to be massive now considering the reported estimates of illegal Indian wealth stashed abroad. The only caveat is whether it will fall foul of the country’s international commitments on money laundering.

(The author is a Mumbai-based economic consultant)

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