Capital inflows will strongly shape RBI?s policy review on November 2, and this would be in step with other central banks. Multilateral agencies too are nudging countries to place curbs on inflows.?
So far this fiscal year, RBI has been content to let the big flows come in because of the country?s burgeoning current account deficit. But when the capital inflows become lumpy and volatile, managing the flows with an intervention in the foreign exchange market will bring to the fore the dilemma of managing the impossible trinity.
According to a popular hypothesis a country can only have two of the following three factors ? a fixed exchange rate, free capital flows and an independent monetary policy. RBI?s objective of keeping liquidity tight and record foreign exchange reserves has restrained the governor from soaking up dollar from the foreign exchange market.
The non-intervention has hurt exports and resulted in a sharp appreciation in rupee.?Strong domestic demand, which is fuelling growth, is yet another reason why RBI has neglected exporters? demand for a correction in rupee?s exchange rate vis-a-vis the dollar.
Since January, the greenback has depreciated against several Asian currencies: 2.6% against the Chinese yuan, 6.9% against Singapore dollar, and 1.83% versus Korean won. Against rupee, it has fallen 5.7%.
In the past roughly eight weeks or since August 31, amid big capital inflows, the rupee has fluctuated between Rs 43.97 and Rs 46.98 per $1.?This volatility has made it difficult for exporters and importers to frame strategy.?
Last week, the International Monetary Fund called upon Asian central banks to take steps to curb inflationary pressures and also capital inflows. ?Managing capital inflows into the region is a difficult challenge. These inflows present many opportunities but they also pose potential risks to financial stability,? IMF said in its latest regional economic outlook for Asia and the Pacific.
An indication of the shape of things to come was given earlier this month by Subbarao while participating at a panel discussion at the IMF in Washington.?
On October 10 in Washington, Subbarao threatened with intervention if inflows continued to be ?lumpy and volatile or if they disrupt the macroeconomic situation?. ?Our intervention will be to keep liquidity conditions consistent with activity in the real economy and to maintain financial stability,? he said. In September, India received record $6.4 billion overseas flows into stocks compared with $2.4 billion in August and $3.7 billion in July as fears of double-dip recession ebbed.?
RBI?S findings in mid-quarter review on September 16
* If this (improvement in global sentiment and steady rise in capital flows into emerging market including in India) trend continues, the risks on the external front will clearly abate despite exports remaining sluggish.
What happened after policy review?
* In September, the country received record capital flows for a month as fears of double-dip recession ebbed.
* RBI governor D. Subbarao on October 10 said absence of the central bank?s intervention in the past years does not mean that it won?t intervene.
* ?If the inflows are lumpy and volatile or if they disrupt the macroeconomic situation, we will do so (intervene),? Subbarao said.
* ?Our intervention will be to keep liquidity conditions consistent with activity in the real economy and to maintain financial stability. And not to stand against developments driven by changing economic fundamentals,? RBI governor said.?
* Planning Commission deputy chairman Montek Singh Ahluwalia said the country?s ?first priority is foreign direct investment and the second priority is portfolio investment?. He, however, expressed confidence that India will be able to absorb the excessive inflows owing to its widening current account deficit.
