RBI tightens capital flows by banks

A day before announcing its 2007-08 annual monetary policy, the Reserve Bank of India (RBI) has put on hold the proposed increase in the ceiling on overseas borrowings by banks to check further capital inflows.

In its mid-term review of the 2006-07 monetary policy, the central bank had raised the ceiling on overseas borrowings by banks to 50 per cent of their unimpaired tier-I capital (equity, reserves plus perpetual debt) from 25 per cent.

Today, however, the RBI said, "In view of the prevailing market conditions and the likely impact on liquidity, it has been decided to keep the operationalisation of the policy announcement (ie the notification) in abeyance."

Net capital flows surged to $27.3 billion in the first nine months of 2006-07, from $13.4 billion in the same period a year earlier. Indian companies and banks raised $28.71 billion from overseas markets in 2006-07, 29 per cent more than a year earlier.

The abeyance of the increase in overseas borrowings by banks comes amid expectations that the RBI will make external commercial borrowing norms stricter in terms of end-use requirements.

The RBI is also expected to ask companies raising funds overseas through the automatic route to first report it to the central bank against the current practice of post-factor reporting.

"The RBI's move is aimed at checking additional supply of liquidity and controlling capital flows," said Sudhir Joshi, head treasurer at HDFC Bank.

The large inflows have resulted in the rupee appreciating sharply. In March 2007 alone, the rupee rose 2.2 per cent and by over 9 per cent since July 2006 on account of strong foreign inflows.

The inflows have also impacted money supply, which has been growing at over 20 per cent year-on-year, way ahead of the 15 per cent target indicated in the Annual Policy Statement for 2006-07.

This, in turn, has fuelled inflation, which has been over 6 per cent in the last three months, above the central bank's tolerance threshold of 5.5 per cent.

For foreign banks, however, the RBI's decision to defer raising the overseas borrowing limit has come as a relief because the RBI had included short-term borrowings (of up to a year), which are used by banks to provide export credit, within the overall ceiling.

The RBI had restricted short-term borrowings to 20 per cent of tier-I capital within the overall foreign borrowing.

"Most foreign banks would have exceeded the 50 per cent limit with the inclusion of trade finance," said a banker.