By Shyamala Gopinath
The financial meltdown has resulted in effective nationalisation of major financial institutions in the US, UK and Eurozone. So far global banks, mortgage lenders and insurance firms have announced write downs of over US$ 800 billion. There has been a massive increase in central bank lending to the banking system and rescue packages totalling almost US$3 trillion have been announced by governments around the world.

Monetary policy has been eased aggressively but given the lagged impact attention has shifted to fiscal policy. From this side, I can say that the past year has indeed been a challenging one which has reinforced the futility of finding clean corner solutions to evolving situations and each decision necessarily involves managing different objectives while finding the immediate focus points without dissipating the gains of reforms undertaken.

Forex markets in India – Recent Developments
As far as the Indian foreign exchange market is concerned, during the last five years the sources of supply and demand have changed significantly with large transactions emanating from capital account unlike in the past when current account transactions dominated the foreign exchange market. The behaviour as well as the incentive structure of the participants who use the forex market for undertaking current account transactions differ significantly from those who use the market for capital account transactions.

Therefore managing the capital account, particularly debt flows, even while we are getting more integrated is an important instrument in our overall macroeconomic management. In the last few years we had to address the challenge of large capital inflows and had therefore in consultation with Government taken certain measures to calibrate these flows by requiring external commercial borrowings (ECB) to be used for foreign currency expenditure.

Measures to liberalise outflows for resident individuals, mutual funds, and corporates were also pursued. The global financial crisis and deleveraging have now led to reversal and / or modulation of capital flows particularly foreign institutional investor flows, ECBs and trade credit.

In response to the emerging global developments, the RBI has taken a series of measures to augment forex and domestic liquidity. Some of the measures taken to augment forex liquidity are:

• USD dollar swap lines of up to USD 10 billion for Indian banks with overseas branches and subsidiaries. The actual utilisation, as of January 9, 2009 is only USD 247 million.
• Increasing interest rate ceilings for FCNR(B) and NRE deposits to LIBOR / SWAP rates plus 100 basis points and LIBOR / SWAP rates plus 175 basis points respectively.
• ECB policy, which is an instrument of capital account management, has been liberalised to revert to the pre-May 2007 period. It may be recalled that due to large capital flows, the end use of ECB proceeds was limited to foreign currency expenditures. Further liberalisation in terms of expanding eligible borrowers and end use has also been undertaken viz:
• Housing Finance Companies, registered with National Housing Bank (NHB) have been permitted to raise short- term foreign currency borrowings
• NBFCs, which are exclusively involved in financing of the infrastructure sector, may avail of ECBs from multilateral / regional financial institutions and Government owned development financial institutions for on-lending to the borrowers in the infrastructure sector under the Approval route.
• Payment for obtaining license/permit for 3G Spectrum will be considered an eligible end - use for the purpose of ECB.
• The corporates in the Hotels, Hospitals and Software sectors to avail of ECB up to USD 100 million per financial year, under the Automatic Route, for foreign currency and / or Rupee capital expenditure for permissible end-use.
• Spreads on ECBs and trade credits were increased and the all-in-cost ceilings on ECBs were dispensed with under the Approval route.
• Limit on overseas borrowings by banks was enhanced from 25 percent to 50 percent of unimpaired Tier I capital. Overseas borrowings for on-lending to exporters continue to remain outside the ceiling.
• In order to enable EXIM bank to continue to offer buyers credit against lines of credit as well as preshipment and post shipment finance, RBI has extended a line of credit of Rs 5000 crore.
• EXIM is also eligible to avail of swap facility up to USD 1 billion under the facility permitted for banks.
• The FII limit for investment in corporate bonds has been hiked to USD 15 billion from USD 6 billion.
The Indian foreign exchange market has grown significantly in the last several years. The daily average turnover has gone up from about USD 5 billion per day in 1998 to more than USD 50 billion per day in 2008. There is also evidence of growing merchant turnover reflecting the huge increase in external transactions
The spot foreign exchange market remains the most important segment but the derivative segment has also grown. In the derivative market foreign exchange swaps account for the largest share of the total turnover of derivatives in India followed by forwards and options.

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