External Developments

Reviewing the developments
11 October 2000

Dr. Jalan attributed several factors that influenced the forex market in the country between May-August 2000. According to him factors such as "expectations", "bandwagon effect" and "volatility in capital inflows", played a major role in exchange rate movements and it was not possible to come to a definitive conclusion about the relative role of each of these factors.

The governor observed that while it was difficult to estimate the precise cause and degree of volatility, a combination of measures had to be resorted to in order to minimise the adverse impact of this volatility on the rest of the economy. He also stated that reliance on one or two measures like sharp monetary tightening, unchecked depreciation of the exchange rate, and/or unlimited use of reserves could have had unacceptable longer term consequences for the economy. all of which could have lead to a greater risk of irreversible destabilisation.

The governor called for exercising extreme care and caution in the management of exchange rates and forex reserves in light of the uncertainty in the direction of capital flows in a floating rate environment.

The continued good performance of exports, particularly software exports, coupled with a comfortable level of foreign exchange reserves and a favourable outlook for foreign direct investment in certain important sectors like information technology and telecommunications, has helped cushion the adverse impact of the spiraling rise in crude oil prices. Despite substantial increase in the oil import bill, increase in exports and invisible receipts was expected to keep the current account deficit for the year 2000-2001 at less than 2 percent of GDP.

The monetary policy for the second half of 2000-2001

With liquidity conditions likely to remain adequate during the rest of the year, the banking system is not expected to face any difficulty in meeting the demand for credit. The RBI reiterated its commitment to providing liquidity, where necessary, through its Liquidity Adjustment Facility (LAF). The LAF, introduced since June 2000 was being used to influence short term interest rates by modulating day- to-day liquidity conditions and to contain volatility in the forex market. The LAF would continue to be operated in a flexible manner, both in terms of rates and tenors in keeping with the developments in the financial markets.