‘Move towards capital account convertibility will be gradual’.
India’s foreign exchange reserves are more vulnerable to reversal of capital inflows as compared to countries with current account surpluses, Reserve Bank of India (RBI) Governor Duvvuri Subbarao said on Monday.
“Our reserves comprise essentially borrowed resources, and we are therefore more vulnerable to sudden stops and reversals as compared with countries with current account surpluses,” Subbarao said in a speech at the Special Governors’ Meet in Japan.
Subbarao said it was important to distinguish between countries whose reserves were a consequence of current account surpluses and countries with current account deficits whose reserves were a result of capital inflows in excess of their absorptive capacity.
The country’s total foreign exchange reserves were at $297.418 billion in week to January 14, up $12.25 billion on year. In the first half of the current financial year, foreign institutional investors (FIIs) have invested more than $30 billion in Indian equity and debt markets. But so far this month, they have pulled out around $1 billion from the stock markets.
India did not have a deliberate strategy to accumulate foreign exchange reserves, Subbarao said. “Although India does not have a deliberate strategy of building up reserves for self-insurance, our reserves got built up as a result of our relatively flexible exchange rate policy. The reserves so built up have been used to contain volatility in the event of capital flow reversals,” he said. In the recently published Financial Stability Report, the central bank had expressed concern that India’s foreign exchange reserves had not risen much in the recent past and this was a risk in the event of large outflows.
India has witnessed a flood of fund inflows as well as sudden stops in the past.
“We prefer long-term flows to short-term flows and non-debt flows to debt flows,” he said.
In the third quarter review of the monetary policy, RBI had expressed discomfort over financing the current account gap with short-term capital inflows. As a source of funding the current account gap, FIIs posed a threat due to their unsustainable nature, RBI said.
India’s current account deficit hit an all time high of $15.8 billion in July-September.
Subbarao said capital account convertibility was not a standalone objective and the move towards it should be gradual.
“India has followed a consistent policy on allowing capital inflows in general and on capital account management in particular. Our position is that capital account convertibility is not a standalone objective but a means for higher and stable growth. We believe our economy should traverse towards capital convertibility along a gradual path — the path itself being recalibrated on a dynamic basis in response to domestic and global developments,” he said.
“Historically, we have used policy levers on the debt side of the flows to manage volatility. Contrary to popular perception, we have used both quantity and price=based variables to moderate debt flows,” he said.
