Ashwani Mahajan

n recent weeks, the steep fall in the value of rupee had surprised the nation. Although the rupee has improved to almost 62 to 63 to the US dollar after falling to 68.81, most people are able to understand  how the rupee depreciated by more than 20 per cent in just four months. Economists have tried to explain weakening of rupee in their own way. Policy makers and the ruling class are providing yet another analysis. However there is consensus among all that this decline in the value of rupee was caused by increase in imports – mainly of gold, coal, telecom and engineering equipments and of course oil even as its international price rose. Since foreign debt of nearly $172 billion has to be repaid by March 2014, demand for dollars in expected to increase even further. Rupee is under great stress and that is making it weak. There is consensus that rupee is under pressure, however there is school of thought that says speculative trade in currencies has deepened the crisis.
Analysing the ups and downs in the value of currency, we find speculation accentuates the upheavals. Reserve Bank of India, which is the custodian of foreign exchange reserves and also the sole regulator, can attempt to regulate and control interbank currency trade and speculation in domestic market (namely forward trading, options and futures, derivatives etc.). However offshore non-deliverable forward (NDF)  trading in currency cannot be regulated by RBI. Today we find three types of currency markets operating. One is the interbank spot market and forward market. The second is currency futures, options and derivative market; and the third is the offshore market for NDF trading.
Prior to 2008 speculating trade, future and options etc. were not permissible in India. But after it was allowed in 2008, speculating trade in foreign currencies has been rising continuously. Currency trading has increased from $ 2.6 billion in September 2008 to $234.4 billion in June 2013, that is a 90-times increase. One can understand the implication of rising speculation on the value of rupee vis-à-vis other currencies.
A couple of months back, RBI banned currency futures and options trading by banks and  financial institutions and now they can undertake these transactions only on behalf of clients. SEBI has also tightened its noose on currency derivatives. However experts believe that RBI and SEBI cannot stop speculation in currency.
Nobody can deny that upheavals in exchange rate are driven by speculators. Speculators work with the objective of maximising gains in the short run. In fact actual demand and supply for a currency do not have much bearing on the value of currency, as these speculators can create artificial scarcity of dollars (or any other currency). Although this characteristic of speculation and speculators applies to all goods, it is applicable more on currencies. In its recent Annual Report, RBI has referred to a research study that says there is long run relationship between spot transactions and offshore NDF transactions. When a currency is depreciating, upheavals in offshore NDF markets have significant impact on spot transactions. Though relationship between the two is not defined, it is likely that banking institutions are involved. The report adds that while domestic banks and other financial institutions are not allowed to engage in such types of NDF trading, there are chances that they are linked with trades directly or indirectly. Also sometimes foreign banks and companies having their offices overseas can definitely participate in such deals.
In 1975, 80 per cent of the foreign currency market was dedicated to real transactions like export-import, investment etc. and speculation accounted for only 20 per cent of currency trading. However, now only 1.5 per cent of currency trade is for real transactions and 98.5 per cent for speculation. Today globally nearly 4 trillion dollars of currency trade takes place daily, that is, 1460 trillion dollars annually, whereas annual export and import of goods and services is hardly 22 trillion dollars.
No doubt, to facilitate international transactions, one needs foreign exchange. However unregulated foreign exchange market leads to crisis like the one we are facing. Global financial institutions that are in possession of surplus finds indulge in speculative activities to make a quick buck. Experts believe that RBI can regulate or restrict speculation of foreign currencies within India; however it has no control over offshore trade in NDF. But this trade affects the market exchange rate. Thus RBI and the government will have to find out innovative measures to regulate and restrict these offshore transactions having bearing on the domestic foreign exchange markets to effectively bring down upheavals in the value of rupee.

The writer is Associate Professor of Economics at PGDAV College, University of Delhi.