RBI?s credit policy statement on Tuesday will come in the backdrop of strong signals coming from New Delhi that monetary accommodation should continue for some time until industrial recovery is firmly in place. Interestingly, for the first time in recent years, Cabinet ministers, bureaucrats as well as economists working in the government have gone on record that the central bank must maintain status quo on interest rates. Business leaders too have sought the continuation of the present interest rate regime. Broadly, RBI is also of the view that there is no reason at present to tighten the monetary policy.
However, the central bank is more concerned about what might happen over the next six months to a year. The credit policy statement will outline RBI?s view on these issues in a medium-term perspective. RBI Governor D Subbarao and his team would therefore be focused on how to time a gradual exit from an accommodative monetary policy sometime early to mid-next year, depending on how variables such as inflation, output and, most importantly, foreign capital induced liquidity will behave.
The scale of foreign capital induced liquidity is something RBI will have to worry about the most as it will create contradictory pulls and pressures in the management of exchange rate and interest rate. The report of the Prime Minister?s Economic Advisory Council makes a reasonable assumption that net foreign capital flows into India for 2009-10 should touch $57 billion. Keep in mind that net foreign capital flows had peaked at $100 billion in 2007-08 following the unprecedented global liquidity play-out driven by the finance capital boom starting in 2003. When the global liquidity party abruptly ended after the collapse of Wall Street, the net capital inflows into India came down to a mere $10 billion in 2008-09, a 90% drop from the previous fiscal.
The EAC report suggests the net capital flows will recover to $57 billion in 2009-10. If the net capital inflows indeed remain under $60 billion, it should not interfere with RBI?s monetary policy and exchange rate management. My apprehension is that with so much liquidity sloshing about globally, supported by the G-20 consensus that such coordinated monetary and fiscal accommodation must continue, policymakers and central bankers in individual countries would tend to suspend their instinct for taking actions based on specific domestic considerations.
In some sense, 2009-10 may see an officially sponsored liquidity party among the G-20 nations which constitute 75% of the world economy. The key host of this liquidity party remains the US.?Fed Chief Ben Bernanke has said on many occasions that his biggest challenge will be to time the exit of the US?s excessively liberal monetary and fiscal policies. With US interest rates at near zero and fiscal deficit for 2009-10 projected at 13.5% of GDP, the overall economic situation might seem like a nightmare that is not going to end anytime soon. While corporate balance sheets may show some signs of improvement, one is not sure whether they are purely productivity driven in many sectors. Some Wall Street analysts apprehend that the improvement in the balance sheets of Citi and Goldman Sachs are because of freshly leveraged finance capital play. They may not be a reflection of any real sector improvement in the US.
The chief economist of the US Mortgage Bankers? Association said last fortnight that housing mortgage foreclosures and unemployment in the US will peak sometime mid-2010. That is bad news for the rest of the world. Simply because America will continue to export its loose monetary policy through the officially sanctified G-20 platform and make life difficult for emerging economies like India.
This will be exacerbated by the dollar?s continuing decline, real and perceived, which will, in turn, result in the 800-pound gorillas on the Wall Street yet again flooding the emerging markets with their greenbacks. Indeed, if this happens all over again, India may get flooded with much more than the $57 billion of? net capital inflows that the Prime Minister?s Economic Advisory Council is anticipating.
RBI will have a problem on its hands if the dollar inflows peak sometime early to mid next year when industrial recovery is well on its way and the inflation rate too inches closer to 7% as predicted by many.? RBI will then have to craft a gradual exit strategy from monetary accommodation. But that strategy will be marred by a deluge of foreign capital which will do exactly the opposite, i.e create ever more liquidity. At this point, exchange rate management will?become a bigger headache. RBI will be called upon to ensure that the rupee does not appreciate beyond what is seen as a fair value vis-?-vis the dollar. Current wisdom says that level could be in the region of Rs 44 to Rs 45 to a dollar. RBI may have to stem any appreciation beyond this, thereby attracting even more capital flows. One does not envy RBI?s job in such turbulent times!
?mk.venu@expressindia.com
