Strengthening of US dollar against rupee and other currencies
In order to consider short-term developments in the value of the rupee vis-a-vis US dollars in proper perspective, it is necessary to pay attention to what is happening to the value of dollar in relation to other major currencies during the period. Yesterday (August 2, 2000), for example, the rupee depreciated against the dollar by 21 paise (over the reference rate on August 1, 2000) or less than 0.5 per cent. On the same day, dollar appreciated against the Euro by 1.1 per cent and by 0.2 per cent against the Pound Sterling. Similarly, between 1 July and 2 August 2000, the dollar appreciated by nearly 4.0 per cent against the Euro, by 3.2 per cent against the Yen, and about 1.5 per cent against Pund Sterling as well as the rupee.

As a result of the movement of US dollar against these currencies, the rupee strengthened against the Euro by as much as 2.5 per cent, and by 1.5 per cent against Yen, and remained stable against Pound Sterling. These currencies (Euro, Pound and Yen) are currencies of India's other major trading and investment partners. Thus, while it is true that rupee has depreciated against the dollar last month, it is equally true that rupee has sharply appreciated or remained stable against currencies of its other major trading partners in Europe, UK, and Japan. Going beyond the dollar, and taking the movement of the rupee against other major currencies, it is simply wrong to say that rupee has hit "an all time low".

The "Oil Effect" and the "Inflation Effect"
Frequent references have been made in recent days to the effect of increase in prices of crude oil internationally on India's trade and the effect that this may have on the exchange rate. The increase the prices of imported oil has indeed been high. It is also true that this increases in import bill substantially. However, it is important to remember that prices of crude oil were also very high last year also. (They were close to $25 per barrel at the end of December'1999 as against about $26 on August 2, 2000). And yet, last year we added to our reserves by $5.5 billion.

The other point that has been made is the effect of higher rate of inflation on the value of the rupee. The major reason for increase in the rate of inflation in the recent period in India is the increase in the prices of petroleum products, including mineral oils, etc. Excluding this, the impact of an external factor, the annual rate of inflation in India currently is less than 4 per cent. In the US and Europe as well as several other countries, it is normal to exclude the effect of oil prices, and certain other prices, for determining the core inflation rate for purposes of monetary policy decisions and inter-country comparison of inflationary pressures.

As pointed out in statements, the RBI does not use short-term movements in Real Effective Exchange Rates (REER), or any other similar variable, as an indicator of appropriateness or otherwise of exchange rate movements in the short-run. However, as these measures have some importance for research and analysis of longer term trends in international competitiveness, the RBI releases figures of REER in its monthly bulletin for different base year levels using both 5-country and 36-country currency trade weights. The present imputed value of rupee per US dollar, based on the REER (5 country currency trade weight, which is the latest available), is given below:

Despite the increase in our oil import bill as well as increase in non-oil imports in the wake of industrial recovery, the current account deficit in India is still less than 2 per cent of GDP, which is considered by international standards to be low and reasonable. India's exports have also been doing exceptionally well in the current year. There has, no doubt, been a substantial outflow on account of FII funds in the months of June and July 2000, which has reduced the net volume of capital inflows into the country.

The FII funds, by their very nature, tend to be somewhat volatile, and our reserve policy in the last few years has taken this factor into account. India very much welcomes FII inflows, but at the same time, we are aware that these flows in the short run can be affected by legitimate corporate considerations, including developments in markets of other countries.

Movement in India's reserves
The movement in India's foreign exchange reserves in the last five years is shown below:

As can be seen, in the last four years we have added as much as US$16 billion to our reserves. The build-up of reserves is a result of conscious policy which takes into account the changing composition of balance of payments and "liquidity risks" associated with different types of flows and other requirements.

As explained in the Monetary and Credit Policy Statement for the year 2000-2001: "The policy for reserve management is judiciously built upon a host of identifiable factors and other contingencies. Such factors inter alia include: the size of the current account deficit; the size of short-term liabilities (including current repayment obligations on long-term loans); the possible variability in portfolio investments and other types of capital flows; the unanticipated pressures on the balance of payments arising out of external shocks (such as, the impact of the east-Asian crisis in 1997-98 or increase in oil prices in 1999-2000); and movements in the repatriable foreign currency deposits of Non-Resident Indians."

It was further pointed out that: "Unanticipated domestic or external developments, including undue volatility in asset prices in equity/bond markets, can create disproportionate pressures in the foreign exchange market in emerging economies. It is, therefore, essential to continue with the pursuit of realistic and credible exchange rate policies, in addition to vigorous implementation of domestic and external sector reforms to further strengthen the balance of payments position over the medium term."

The reserve management policy pursued by India in the last few years has stood us well and enabled us to cope with various unanticipated events, such as, the east-Asian crisis, imposition of sanctions by several industrial countries a couple of years ago, the Kargil conflict, and changes in Government at home. Our reserves at the present level are strong, and are high enough to take care of any temporary adverse developments in demand as well as capital flows, particularly if unnecessary and unwarranted "panic" is avoided . The Government has also take several measures to enhance the flows of capital, particularly foreign direct investments, and as a result of these efforts, it is expected that we will see a substantial increase in these inflows during the course of current year.

Timing of RBI decisions
In earlier statements as well as the statement made by the Reserve Bank on May 25,2000 (and in the annual and half-yearly monetary policy statements), it has been stated that, RBI does not "target" a specific exchange rate in determining its intervention policy or the timing of monetary policy and other measures announcd by it from time to time. Yet, whenever rupee reaches or is close to a "round number" or a particular level (such as, "the lowest ever in this year" or "in the recent past" in terms of the dollar), it is presumed by analysts that RBI would or should intervene strongly to defend that particular level. If RBI's action at that level is absent or mild, this adds to certain element of speculation about RBI's comfort level or intentions, which in turn creates uncertainties and a rush to the market.

This issue, therefore, deserves some further clarification. The simple point is that when RBI says that it does not "target" a particular level of the exchange rate, it is intended to convey that there is no specific level which it is prepared to defend, through unlimited sales of foreign currency and/or through introduction of strong monetary and other measures. The RBI's view is that past international experience has abundantly made it clear that the defence of a "fixed" previously set target by central banks in developing, as indeed in industrial countries, is simply not practical or desirable in a regime of flexible exchange rates.

This was abundantly brought out during the east-Asian crisis in 1997 and in Latin America in 1998 (as well as in India's case in November 1997 in the wake of the Asian crisis). It has also been the experience of several industrial countries at different times, including Japan. The announcement of a pre-fixed "target", or a commitment to this effect, leads to one way speculation in the currency and can result in a surge in the demand for foreign currency. The erosion in foreign exchange reserves may become unsustainable, leading to abandonment of the pre-announced peg.

The fact that RBI does not target a particular exchange rate does not mean that movements in the exchange market, irrespective of the pace and its level, are matter of no concern and can be ignored. It is also possible that at some levels, which happen to be round numbers, certain measures can be taken. These are, however, not designed to defend the rate at that particular level. (It may be mentioned that while the July 21 measures were taken when the rupee was close to a round number, the May 25 statement by RBI was made when rupee-dollar value was 44.29. At that time, interestingly, nobody observed that this is a "Lakshman Rekha" which RBI must defend to maintain its credibility!)

"Speculative" Vs."Genuine" demand for foreign exchange
India has already taken measures to reduce purely speculative demand for foreign exchange or inter-bank speculation. At the same time, it has to be recognised that, outside of purely speculative demand, "leads and lags" in respect of genuine import demand and export repatriation can also have a very large effect on the demand and supply position in forex markets in the short run. This is because during periods of uncertainty and adverse expectations, genuine importers tend to bunch their demands and enter the market to meet their present requirements as well as their future requirements. Similarly, exporters may hold back genuine export receipts in anticipation of further depreciation.

Thus, while the relative absence of pure currency speculation in our markets is helpful, it does not eliminate short-term pressures in the foreign exchange market by genuine exporters/importers in anticipation of future value of the currency. Thus, even when the sudden accumulation of demand is genuine, it may become necessary to intervene or take measures to stabilise expectations, if feasible.

Why recent Monetary Measures by RBI?
Monetary measures announced by RBI on July 21, 2000, reflected RBI's assessment of developments in the domestic and international markets in regard to liquidity as well as movements in international interest rates abroad, which had hardened considerably over the past year (while Indian interest rates came down substantially). These measures were not designed to defend a specific rate. The purpose of the measures was to shift, at the margin, the relative cost of buying rupees vis-vis foreign currencies in the short-run. These measures were deliberately spaced out, and the quantum of increase was smaller than what would have been required to defend a particular rate.

What would RBI do next?
As already announced, the Reserve Bank will continue to intervene directly or indirectly in the market to meet temporary demand and supply mis-matches. It will also directly meet partially or fully, without entering the market, the foreign exchange requirements for import of crude oil by the Indian Oil Corporation and for Government debt service payments, as considered necessary. (This has the effect of reducing lumpy and "unpostponeable" market demand for foreign exchange).

Reserve Bank will also continue to monitor developments in the market very closely, and take such further measures as may be necessary from time to time in order to stabilise expectations, to the extent feasible, and to help reduce the effects of "leads" and "lags". India's fundamentals are strong, our reserves are high and our policies for management of external markets are pro-active and thereby reasonable. It is hoped that above clarifications will help market participants, including exporters and importers, to take decisions, which are most conducive to promoting orderly conditions in forex markets and help accelerate growth of output and exports.