In a move overshadowed by the monetary policy statement, on April 23, the Reserve Bank of India announced the reversal of an earlier decision, which allowed banks to borrow short-term funds in the international markets, up to 50 per cent of the net worth. In the light of this reversal, I am still at a loss to understand how to interpret the changes in the external account regulations, announced on April 24.

Are these driven by tactical convenience, or by strategic conviction in the virtues of a liberal capital account? (Much of media comment has considered them as falling in the latter category.)

The measures include greater freedom for prepayment of external commercial borrowings and for residents to invest funds abroad. To me, these measures are a classic example of the proverbial banker offering an umbrella when there is little possibility of rain -- it is beyond me why many people would utilise these facilities in the face of an appreciating domestic currency and higher INR interest rates, (but they could still come to haunt the RBI when the situation reverses).

Coupled with the earlier move about curtailment of bank borrowings, and a reduction in interest rates on non-resident deposits, these are all obviously aimed at reducing inflows and increasing outflows, to suit the convenience of conducting monetary policy. (Would they be as lightly subjected to reversal?)

As a package, they paint a somewhat unsettling (and bizarre?) picture of a central bank anxious to promote investments abroad, even as it discourages domestic investments through higher interest rates -- and this in a country which needs to create ten million plus jobs every year, if only to ensure some social stability and guard against ever bigger segments being menaced by the naxalite movement.

But non-resident deposits, ECBs and FIIs are not the only sources of capital inflows. What is being overlooked is the encouragement an appreciating currency and higher domestic rates give to the use of short-term foreign currency credit on imports and exports.

This credit is over and above the increase in bank credit and even the RBI probably does not have a precise idea of the level or changes in leads and lags in a $500 billion current account transactions portfolio. And, these can more than negate the effect of changes the RBI has made.

Meanwhile, except for a few first tier companies, others are paying 6/7/8 per cent real rates. This apart, it seems to me that the exchange rate has become dangerously overvalued.

One example: Many of my firm's clients have stopped accepting new export orders. As it is, the trade deficit has galloped at a 70 per cent per annum compound rate: $14 billion in 2003-04, $34 billion in 2004-05, $52 billion in 2005-06 and $52 billion up to December 2007 in 2006-07. I would be surprised if it is much below $70 billion for the whole year. It may well come to $100 billion plus in the current year given the continuously appreciating exchange rate.

The statement talks of "ensuring a monetary . . . . . environment that supports export". Perhaps they mean other countries' exports! Clearly, the exchange rate policy seems to be aimed at promoting employment abroad rather than at home!

Evidently, exchange rate appreciation is being allowed to mitigate the need to sterilise the impact on money supply, through either MSS or a further increase in CRR. While the former is a cost to the government, I do not see that the latter is a costly "tax" on the banking system, to the extent the CRR increase neutralises the impact of intervention in the FX market. The resources would not be there but for intervention -- and their being impounded should not matter.

A few other puzzles: