Foreign exchange management in post liberalization India and its implications

Abstract

Abstract India’s economic story for the past decade has been of growth and stability. It had managed to achieve a growth rate 6-7% without the volatility observed in the other developing markets undergoing reforms so far. But with the rapid growth experienced by the Indian economy post liberalization and growing foreign exchange inflows to India, the increasing demand of rupee and rupee assets is causing a policy conundrum. Unprecedented FDI in the last 2 quarters of FY2007 left RBI in a sticky situation. On one hand if the RBI continued to absorb the foreign currency inflows, it faced a steady rise in excess liquidity in the markets leading to a rise in inflation and a growing Foreign Exchange Reserve that . And if it were to concede to the upward push on the rupee, the appreciation would hit the competitiveness of India’s exports and the industries relying on them. RBI clearly chose the later and hit hard on the rising inflation with strong monetary policy measures. Q1 FY2008 saw the rupee appreciating nearly 10% which is estimated to have eroded close to 15 billion USD worth of exports. This paper analyzes the two sides of the policy conundrum of how to manage the foreign exchange inflows keeping inflation in check and yet not hitting the competitiveness of our exports. It analyzes the various policy measures that have been proposed and argues for a policy that is effective and sustainable while questioning the rationale and of RBI’s latest measures. It also tries to address the issue of best possible utilization of the existing foreign exchange reserves. Keywords: Foreign Exchange Reserves, Monetary Policy in India