By their very nature, central bankers are trained to be enigmatic. If they speak at all, they do so in such an elliptical manner that you can simultaneously infer something and its polar opposite in. As an example, read the prepared speeches of the grand-daddy of them all, Alan Greenspan, to the US Congress. With an enviable gravitas of position, posture, demeanour, age and experience, Greenspan would deliberately read out long sentences replete with hyphens, caveats and parentheses that few lawmakers could understand, and fewer still could glean for trend breaking signals.

 

The point is that you can rarely see, let aside forecast, distinctly discernible shifts in the policy stance of most central bankers. In this respect, Dr. Y. V. Reddy of the Reserve bank of India seems to be an exception. Although he too is prone to long parenthetical sentences, there have been two instances that I know of where Dr. Reddy has clearly indicated is exchange rate preference.

 

One was almost a decade ago, at a foreign exchange dealers’ conference in Goa in August 1997 where, as a Deputy Governor, Dr. Reddy virtually talked down the rupee. Right up to 20 August 1997, the exchange rate was flat at around Rs.35.80 for a US dollar. Then Dr. Reddy wondered aloud of the wisdom of preserving this long lasting rate. Lo and behold, the rupee quickly began to depreciate. By 30 December, it was at Rs.39.52 per US dollar.

 

The second instance has been the other way around; and Dr. Reddy didn’t talk up the rupee. He simply let it go. As the accompanying graph shows, you can pretty much pinpoint the date: 20 March 2007. From 2 January to 19 March, the exchange rate was drifting in a fairly narrow range between Rs.43.88 and Rs.44.50. Since the period also coincided with heavy dollar inflows, it meant that the RBI was still actively buying dollars to keep it within this ‘desired’ band.

 

 

From 20 March 2007, the RBI effectively stopped big-time intervention to stabilise the exchange rate. The result is apparent in the chart. The rupee rapidly appreciated against both the US dollar and the Euro. By 25 May, the dollar-rupee exchange rate stood at Rs.40.28 (versus Rs.44.06 on 19 March); and the Euro-rupee was at Rs.54.19 (against  Rs.58.60 on 19 March).

 

The abandonment is so sharp and so obvious that it needs no further description.

 

Why so? Clearly, the RBI has had enough. With dollars flowing in like never before and with the Reserve Bank determined to slow the growth of money supply in its attempt to check inflation, intervening to prop the exchange rate was one task too many. It would not only have been increasingly expensive for RBI to sterilise the ever mounting heap of dollars; but also, itI would have probably run out of enough treasury bills to do the needful. In any case, Dr. Reddy has never been known to be a die-hard ‘exchange-rate pegger’. So, he let it go.

 

How much more will he let the rupee appreciate? If dollars keep coming in as they have, I suspect he will keep on testing the water until it reaches a point where exporters cry so loudly that the Prime Minister and the Finance Minister gently request him to intervene more frequently. Actually, what he is praying for is a surge in imports. But that’s not going to happen soon. So, I see the rupee getting stronger before it gets weaker.