The trend seen after the initial stability in the early nineties is a rather straight forward one. For some time, the exchange rate remains glued to a particular level, signalling stability with importers and others having borrowed in foreign currency. Then suddenly it slides, causing panic among them.

The sudden demand spurt when the rupee is sliding comes from corporates who had earlier booked profit when the rupee seemed steady.

Between 1992 and 1995, after India had opted for current account convertibility, the rupee was stable. The exchange rate stood at around Rs 31 against the greenback, with hardly any movement for a long period. But the facade of a stable exchange rate showed signs of trouble towards the end of 1995. The Rs 31 level, which held for so long, slided to Rs 33.20 per dollar in September 1995. Again in October, it slipped by another 4 per cent to record a monthly average rate of Rs 34.50, and in February 1996, before the presentation of vote on account budget by the Congress government, the rupee crashed to Rs 36.63 per dollar.

Since then, there has been a clear trend in the rupee-dollar exchange rate. From the Rs 36.63 level, the currency strengthened to around Rs 34.30, where it remained for some time, till it fell to Rs 35 in May 1996. The political uncertainty at that time and weak coalition governments in the centre told on the rupee. Still it held on to a level lower than Rs 36 till June 1997. By then, however, the inflow of foreign funds to the domestic stock markets had dried up. Exports were stagnating for quite sometime. A crisis also erupted in the South Asian economies.

Since mid-1997 till now, in about a year, there have been at least five occasions when the rupee was battered in the forex market. In August it slipped from Rs 35.50 a dollar to Rs 36.50. Then again in November. It slid in December, too, when the RBI had to adopt more-than-ordinary measures to stabilise the exchange market. Sentiment is overwhelmingly bearish even now. But with the RBI's control firmly in place, banks have little option of indulging in rampant speculation - the major saving grace for the rupee.

The only way of making a killing in speculation is to sell something that is likely to be available cheaper at a later date. Dealers, therefore, will like to sell the rupee and buy dollars. There is only one roadblock here. When a bank sells rupees, it has to borrow the same from the inter-bank market to replenish its rupee stock at the end of the day. To borrow rupees, it incurs a cost - interest cost. If the interest cost so incurred is more than the profit a bank may earn by selling the rupee, it will not indulge in speculation against the currency. The RBI's measures have made it uneconomic to engage in such speculative activities. Yet, rupee has often been coming under intense speculative pressure.

The other measure that may force speculators away from attacking a weak currency is the physical limitation imposed on the amount one can trade. At the end of every trading day, if the currency trader is asked to leave a square position - that is, he can neither sell more rupees than he needs in ordinary course of activity nor can he buy them - he will have little ammunition to attack a currency. The RBI has in place such a restrictive condition. Yet, this did not help much.

The point of worry is that despite so many checks and balances, there are occasional hiccups in the exchange market. Often, the overwhelming feeling is that the rupee is heading for a bottomless pit. During such periods, importers panic and rush for cover. Borrowers in foreign currency, too, rush in. The resultant excess-demand condition in the market puts an extra pressure on the central bank. The condition arises out of the tendency of importers and forex borrowers to keep their payment liabilities unhedged. If probed deeply, one will observe a clear trend in their operations.

Those remitting forex out have been booking profit on their forward cover whenever they find that the rupee has turned relatively stable. They feel that since the rupee is not likely to budge much from the level established, they may earn some extra money by cancelling the forward cover they had obtained at an earlier date. They opt for keeping open their exchange risk hoping that the exchange rate will continue to hold at the level for quite some time. But when the rupee slides, they panic and rush for buying forex.

The RBI has two options to put an end to an unwarranted pressure on the rupee. First, it may restrict buyers of foreign currencies from unwinding any bought position without referring to it. But the measure may face criticism from the liberalisation fan club. The RBI may, therefore, go for the second option. It should impose a transaction tax on corporates while squaring their overbought currency positions. The tax will reduce a corporate's profit margin and thus act as a deterrent. The problem is one of identifying such transactions with precision. One way out could be to impose transaction tax on all forex transactions. Banks will be asked to pay a tax on their daily turnovers in the exchange market. This will immediately widen the spread between the bid and the offer in the market and reduce profitability.

While the step may act against rampant speculation, it will add to the cost of the economy. The administration of such a tax will be also complicated. However, if the RBI imposes the tax selectively on transactions beyond a certain size and leaves the onus on banks to collect and deposit the tax, a lot of possible problems of tax administration may be solved. If at a later date investigations reveal that banks have failed in discharging their duty, they may be fined for the lapse. Thus banks like SBI, which handles large- value transactions on behalf of the IOC, defence and other official operations, may be kept outside the purview of such a tax for these transactions. Implemented properly, unwarranted speculation from corporates will be curbed, and the forex market will see much less volatility than it is witnessing of late.