Under such circumstances, it is quixotic to expect the market to put a valuation on the rupee. Putting it simply, there are two courses of option open to a central bank. It can let the market set the exchange rate, but that would mean freeing the market, so that the rate reflects the views of the market players. The pro and con views would ensure a fair value for the currency. The second option is not to have a proper market at all, but to let the value of the rupee be determined by trade transactions. The Reserve Bank has been all in favour of the latter course, and has effectively throttled the forex market. By severely restricting the market, the Reserve Bank has a responsibility to let market participants know what the fair value of the rupee should be. If it does not do so, the absence of a proper market would lead to one-way bets and volatility.

To be fair to the RBI, it has managed the rupee very well. There are also cogent arguments why forex markets in developing countries should not be freed. But it does not make sense to say, as central bank spokesmen have said, time and again, that they allow the market to determine the level of the rupee, and merely intervene to calm volatility. It is the Reserve Bank which determines the market.

Copyright © 1999 Indian Express Newspapers (Bombay) Ltd.