Inflation fallout to slow RBI capping FX inflow, rupee surge

RBI will not take any strong measures to moderate the inflow of capital from foreign investors even as it cautions that such inflows are a potential threat, economists said. Up to October 7 this year, capital inflows were $20.3 billion, a historic high. Rupee surged nearly 5% against the dollar during the same period. ?(Capital flows are) emerging as a potential threat and we are clearly thinking of ways in which we can deal with it,? RBI deputy governor Subir Gokarn said earlier this week. ?It is becoming a larger global problem because of the imbalance that there is so much of liquidity and the returns are skewed towards emerging markets,? Gokarn added. RBI officials have often despaired on how management of ?volatile? foreign fund inflows is a challenge. Reserve Bank?which is uncomfortable with steep appreciation or fall in the exchange rate?intervenes to moderate volatility in the Indian currency.

INTERVENTION DOWNSIDE

Despite the big flows and Gokarn sounding the alarm, most economists are sanguine because intervention will counter RBI?s focus on battling inflation. ?I don?t think there is a case for intervention in rupee market now,? said A Prasanna, economist and vice-president at ICICI Securities. Prasanna said he ?will be a surprised if they intervene now, especially with inflation at high levels.?

RBI?s interventions to curb rupee?s rise will involve infusion in the market of rupees to absorb the big supply of dollars. Such a step would add to banking system?s liquidity, which will contribute to inflationary pressures. And to control inflation, RBI wants liquidity to be in a ?deficit mode?.

CAUTION PREVAILS

The appreciation of the rupee?s exchange rate might hurt exports. But concerns about that have to be deferred until the inflation battle is fully won, economists said. RBI might allow some appreciation in the rupee and start worrying about currency appreciation only after inflation moves into comfort zone, said Prasanna of ICICI Securities. In recent months, inflation has been sliding: in August it was 8.5%, down from 9.8% in July and from the peak of 11.0% in April. Yet, inflation level is above the 5-6% that RBI prefers. And, of course, it is also higher than RBI?s March-end estimate of 6%. Abheek Barua, the chief economist of HDFC Bank, too rejects rupee?s appreciation will invite RBI action. ?RBI will not do anything extreme at this stage,? said Barua. Intervention would be calibrated to ?how much appreciation the currency will sustain?, he said. In recent weeks, the rupee?s rise has coincided with the battering of the dollar because US officials have hinted at more stimulus measures to support the fragile economy. And it has also suffered also because China has said it will allow only a gradual increase in its currency flexibility.

?A comforting factor is that all emerging market currencies are moving up,? said HDFC Bank?s Barua. (See table at bottom of story on the dollar?s movements against Asian currencies.) Outlook for the US currency remains weak, while higher yielding currencies like the rupee are seen remaining a favourite with foreign investors. If direct intervention through purchase of dollars is unlikely, RBI might adopt other, softer, means to control the massive inflows, say economists and foreign exchange market analysts. Other measures that could be looked at by policymakers include a curb on overseas borrowings by companies and lowering of interest rates on deposits held by non-resident Indians with banks here.

Here are views of some economists on RBI intervention:

* RUPA REGE NITSURE, CHIEF ECONOMIST, BANK OF BARODA

?RBI will wait and watch how continuously flows are coming and then only they will take some call. They may put a cap somewhere. ?(The appreciation) doesn?t augur well for export oriented units and also too much money will start chasing too few goods and add to inflation. So, RBI will certainly like to control it.?

* VIVEK KUMAR, SENIOR ECONOMIST, YES BANK

?For the past three-four weeks, rupee?s appreciation has been quite rapid and that has increased overall volatility. This could lead to some RBI discomfort and to curb increased volatility, the possibility of an intervention in the foreign exchange market cannot be ruled out. ?RBI?s intervention will not aggravate inflation as long as intervention is fully sterilised.?

* AV RAJWADE, DIRECTOR, AV RAJWADE & CO, FOREX CONSULTANCY

?Reserve Bank of India?s non-intervention in the foreign exchange market is disastrously affecting our exports. ?Its intervention will not heighten the inflation problem if its sterilised. I don?t see the reason why it has not intervened till now.?