Inflation prime worry; capital flows not a concern at present.
Managing inflation may be the biggest task for the Reserve Bank of India (RBI), but it on Thursday said management of large government borrowings next year and modulating the pace of exit were the two other challenges facing policymakers.
In the first-ever Financial Stability Report released on Thursday, RBI also said unlike this year, when the net supply of fresh paper was lower than the net borrowings of the Centre, there was limited appetite for government securities from banks, insurance companies and other institutional investors.
While the Centre’s gross borrowings are projected to rise by Rs 6,143 crore to Rs 4,57,143 crore in 2010-11, net borrowings are budgeted to decrease to Rs 3,45,000 crore from Rs 3,98,411 crore.
This year, RBI resorted to open market operations and desequestering of market stabilisation scheme (MSS) bonds to manage the impact of the high borrowings by the government. Now, the stock of MSS bonds is virtually exhausted, leaving RBI to rely largely on open market operations (OMO) in 2010-11. Bank of America-Merrill Lynch has estimated that RBI may have to resort to OMO to the tune of Rs 50,000 crore in the first half of the next financial year.
The borrowing concerns, and the expectation of higher interest rates to tame inflation, are already showing in the markets, with the yield on the 10-year paper hitting a 17-month high of 8.03 per cent, though it has softened since and closed at 7.88 per cent on Thursday.
On the exit policy, RBI said the task in India was complicated due to multiple factors. One, it said, unlike developed countries, India was confronted with an upturn in inflation. Two, domestic consumption and investment demand, the traditional drivers of growth, needed to be revived. Three, supply constraints, unlike the advanced economies which are demand-starved, will re-emerge and may indeed become binding. Four, the report says, India has to deal with twin deficits, fiscal and current account, and it is critical to downsize the government borrowing programme.
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“However, the exit strategy from fiscal support requires to be modulated in accordance with the evolving macroeconomic developments,” it said.
While inflation remained the prime worry, RBI said the process of unwinding had started and growth appeared more stable.
Besides, it said, at present, there was little evidence to suggest that the quantum of capital inflows had exceeded the absorptive capacity of the economy. But, it warned that capital flows could pose a problem if the expectation of a surge materialised.