Thus, in 1999-00, India’s exports were about $ 30 billion; and given the freedom to invest these for 3 to 6 months (180 days) abroad, about $ 15 bn on average were invested abroad by exporters alone.  Their decision to bring these back to India depends on the forward (three to six months hence) rupee-dollar rate and the interest they earn on their investment abroad and the interest they are likely to earn in India if they repatriate these funds. This firmly linked the domestic money market to foreign exchange market. This, it was hoped would further ease cost of funds through providing access to foreign savings.

The surge in capital inflows during 1993-94 ($ 4 billion in 4 months) from the FIIs, and its impact on the value of the rupee forced the RBI to intervene in the foreign exchange market. The resulting liquidity due to increasing reserves required a sterilisation strategy, which was only possible by persuading banks to purchase government securities at attractive rates. This, combined with government’s own borrowing kept the interest rates high.

By the next year (95-96), interest rates were marginally lower (15-17 percent) and the rupee was stable.  With export growth at 20 percent and inflation down to 7 percent, the economy had recovered from the squeeze of 1991-93. The RBI boasted in its Annual Report about the stability its policies had provided the economy and began to signal lower rates and easier liquidity through lowering of the SLR. It also allowed banks to invest abroad a proportion of their Tier I capital and funds raised from Non Resident Indians. But this was short-lived.

By September ’95, the rupee came under pressure and in a few weeks depreciated by more than 10 percent to touch the Rs 35.6/$ mark. Cancellation of forward contracts by exporters created a mismatch between demand and supply in both spot and forward markets. The RBI intervened and sold more than $ 1.5 bn. in the spot market but could not stem the slide. Like last month, the RBI began by imposing surcharge on import finance and export credit. It began to withdraw liquidity from the system and short-term rates rose to 55 percent. Soon the pressure shifted to the forward market forcing the RBI to intervene and by January 96, the RBI forward liabilities exceeded $ 2.2 bn. By February96 the rupee was down to Rs 38/$. With further tightening of credit and a hefty rise in interest rates, the RBI managed to stabilize the rupee at Rs34-35/$.  By then its monetary policy was in tatters and it was months before the RBI started lowering interest rates again.

A similar incident in late1997 demonstrated that large reserves and capital inflows do not necessarily give the central bank of a country like India power to shape a growth oriented monetary policy. The rupee was stable between January and September 1997 and the RBI had mopped up more than $8 billion. Industry was groaning under high interest rates and the RBI lowered the CRR to 10 percent in small steps and further to 8 percent in October 1997.

There was a speculative attack on the rupee triggered by a marginal withdrawal of FII funds from India due to the crises in South East Asia. The RBI intervened by selling  $ 3.5 bn in few weeks, but failed to prevent the rupee slide. Soon it was forced to raise CRR to 10 percent in November 1997 and by another half percent in January 1998 while the bank rate was raised by a hefty 2 percent. This time the RBI was marginally

lucky, as recession had lowered demand for credit and banks were flush with funds, moderating the increase in interest rates. However the cut in CRR and lowering of rates was once again pushed back. Since 1999 the Reserve Bank has been signalling that it is keen to lower the interest rates in the economy. It has reduced the bank rate and reduce cash reserve ratio to an all time low of 8% of deposits. The demand for lower interest rate has also been articulated by Indian Industry which was facing severe competition from cheap imports and dumping of many commodities by East European producers.

The trade liberalisation and the permission given to Gold imports have given rise to widening a trade deficit. On the other hand the raising of the interest rates by the US Federal Reserve has let to outflow of capital from the FIIs. Just by June the demand for dollars by importers began to run ahead of the supply leading to a downward pressure on the rupee. The Reserve Bank threatened to intervene and raised interest rates on imports finance. But this failed to prevent the depreciation of the rupee. Simultaneously Reserve Bank began to meet government’s loan repayment obligation from its own reserves and has during the last two months reduced the reserves by about dollar 2 billion.  However, like the earlier periods, none of this has helped to stem the decline in the value of the rupee. Ultimately, RBI was forced to raise interest rates and tighten availability of funds to provide an inducement to exporters to repatriate funds back to India.

This loss of control over monetary policy and the high interest rates regime that has resulted from this mindless liberalisation of the external sector has had a disastrous impact on the Indian industry, on the government finances and even on the stock market.

Firstly, the raising of interest rates has meant that even government was forced to borrow at increasing rates, thus further worsening the government’s deficit. Rajwade has estimated that if the interest rates were lower by about 3 percent over the 1990s, Government’s debt would have been lower by Rs 100,000 crore and fiscal deficit in 1998-99 lower by Rs 25,000 crore. (Rajwade, 2000)

The cost of high interest rates on private industry has been more detrimental. Corporate profits (and hence government’s tax collection) were lower. Instead of helping in raising the profit rates and hence taxes, the government has taken the softer option of trying to borrow money from FIIs.  On the other hand, banks find it very risky to lend in a regime of high interest rates, since high interest also raises the possibility of business failure and bankruptcy. Many of the weak banks have started practising what is known as ‘narrow banking’.

The regime of high interest rates, in real terms the highest in our history, has also made the task of corporate restructuring very costly and difficult. The reluctance of the banks to lend to weak firms and rising interest costs has worsened the condition of several public and private sector firms. Many of them were forced to raise equity as debt was too costly and this led to the decline in their share prices and market value. By 1995-96, Multinational predatory firms were on the prowl, and entire sectors of the Indian industry are being gobbled up by the MNCs. Not through competition or making cheaper and better products, but through their access to cheap capital.

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