Bank to continue with exchange rate policy

The Reserve Bank of India has said that it will continue with its present exchange rate policy of focusing on managing volatility with no fixed rate target.

In its statement on the Monetary and Credit Policy for the year ‘02-03, the central bank has said that despite several unexpected external and domestic developments, India’s external situation continues to remain highly satisfactory.

“RBI will continue to follow the same approach of watchfulness, caution and flexibility while dealing with the forex market,� the statement said. Recent international research on viable exchange rate strategies in emerging markets has lent considerable support to the exchange rate policy followed by India.

A number of countries (including those in East Asia) are now following similar policies, the central bank said.

The RBI has said that another important reason for vigil on the exchange rate is the likely effect of adverse developments in forex markets on the real economy, as has been seen in several East Asian and Latin American countries a couple of years ago, and in Turkey and Argentina recently.

“The “contagion� effect is quick, and a sharp change in the currency value can affect the real economy more than proportionately. Exporters may suffer if there is unanticipated sharp appreciation and debtors or other corporates may be affected badly if there is a sharp depreciation, which can also lead to bank failures and bankruptcies.�

The central bank, based on its comfort on the exchange rate front, has allowed banks greater operational flexibility on their borrowings in the overseas markets.

“There is some degree of comfort on the exchange rate front, which is why they have increased the borrowing limit of banks in the overseas markets,� said Romesh Sobti, country head, ABN Amro Bank (India).

At present, banks in India are allowed to borrow from and invest in the overseas market only up to 15 per cent of their Tier I capital or $10m, whichever is higher.

The RBI has now allowed them to borrow up to 25 per cent of their unimpaired Tier I capital from overseas market. The borrowings should be within the banks’ Open Position Limit and maturity mismatch limits (Gap Limits) for which detailed guidelines will be issued.

On the same lines, the existing limit of 15 per cent of unimpaired Tier I capital for investment in overseas market is being raised to 25 per cent of unimpaired Tier I capital.

The investments in money market instruments will be within the existing Open Position Limit and maturity mismatch limits (Gap Limits). This will ensure uniformity in overseas borrowing and investment portfolio of banks.

The increased borrowing limit would enable banks to get cheaper funds and help them to have adequate rupee resources and thus reduce the cost of funds for the banks.

While it will enhance the process of integration of Indian financial market with the global market, different segments of the domestic market will also get further integrated.