In the wake of the RBI monetary policy review meet, Governor Raghuram Rajan ruled out any major disruptions in domestic markets as and when the US Fed hikes its record low interest rates.
In the wake of the RBI monetary policy review meet, Governor Raghuram Rajan today ruled out any major disruptions in domestic markets as and when the US Federal Reserve hikes its record low interest rates and that he is not worried about its impact on the Indian economy.
“We are not worried about the effects on us when the Fed acts, but we do think there will be volatility the world over,” the Reserve Bank of India (RBI) Governor Raghuram Rajan told analysts in a conference call here today.
The impact of the Fed action has already been factored in by the markets the world over as it is one of the “most awaited things in history in recent times and so nobody really reacts when it happens,” Rajan said.
“Still it is prudent to just wait and see and then take action,” he added.
When asked if there is need to wait until the Fed acts to increase the cap on foreign holdings in government debt, Rajan answered in the negative.
“If the Fed action is delayed beyond September, we certainly won’t hold back our market reforms waiting for external developments,” Rajan said.
However, he was quick to add there is a fair amount of expectation that the Fed would start increasing its near zero interest rates from September.
After the 2008 global financial crisis, that began in the US, the Fed has brought down its short-term interest rates to a low of 25 basis points even while it flooded the US and global markets with trillions of US dollars in two rounds of quantitative easing.
In the past seven years, the Fed has been linking a rate hike to better employment scenario, which of late has been normalised. Last week Fed chairperson Janet Yellen said that she would act as early as September or as late as December.
On the plan to gradually increase the foreign portfolio investors cap on holding in government debt, Rajan said “I think it’s prudent to (long term money with higher holdings for foreign portfolio investors).
“Also, given the state of liquidity in the market, it doesn’t cost us too much to wait. But once we get a good sense of either the fact that nothing really is going to happen on the external side for sometime or that it has happened and the consequences haven’t been significant, we will have room to act.
“But, by and large, sooner rather than later it (higher holding limit for foreign portfolio investors) will happen,” the RBI Governor said.
Earlier in the day, Rajan said that the RBI is in discussions with the government to raise the FPI caps, adding that the new structure will be in place before the end of September.
“I don’t think the consultation with the government will take too long a time but we are also looking for appropriate market conditions. You don’t want to introduce this in an environment of excess liquidity and see a lot of flows come in,” he said.
After discussions, RBI will formulate a framework to raise the investment limit for such investors in government debt securities, which will be pegged to the rupee against the current practise of linking it to the dollar, he said.
“The overall goal of this medium-term framework will be to enlist FPIs in market development within prudential limits which we set even as they are attracted by the rates available in domestic bonds,” Rajan told reporters at the customary post-policy press meet.
The proposed framework, expected by the next month, will include a target for what fraction of the sovereign bond market will be constituted by FPIs in the medium-term.
It will also consist of an announcement of staggered changes in limits every six months, with limits being released on a monthly or quarterly basis on which the decision is yet to be taken, the Governor said, adding the limits will be specified in rupees so that they do not vary with exchange rate movements.
Currently FPIs can invest up to USD 31 billion in government bonds and an additional USD 20 billion in other debt instruments. Both these caps are almost fully exhausted and foreign investors have been calling for a higher limits.
The RBI has barred FIIs from investing in short-term debt to encourage long-term flows and reduce dependence on hot money. It hasn’t allowed fresh foreign investment in government bonds since raising the ceiling to USD 30 billion in 2013.
To check any possible turbulence after the Fed action, the RBI has been shoring up the forex reserves which currently stands at around USD 354 billion. Since March 2014 alone, the RBI had ramped up the forex reserves by USD 105.8 billion.