The Reserve Bank of India (RBI) today ruled out any imminent intervention in the foreign exchange market, saying capital inflows are still not lumpy and volatile.
"Capital inflows have not reached an alarming level as it had happened in 2007 and therefore there is no room for immediate action by the Reserve Bank," RBI Governor Duvvuri Subbarao told newsmen during his customary post-policy press conference here.
Earlier in the day, the RBI upped the key policy rates or short term lending (repo) and borrowing (reverse repo) rates by 25 basis points each to 6.25 and 5.25 per cent, respectively, to rein in inflationary expectations, while leaving the cash reserve ratio unchanged at 6 per cent.
To a question on what is the threshold level of capital inflow to which RBI is comfortable, Subbarao said, "There is no comfort level as such. Overall, so far it has been roughly in line with our expectations. But in 2007 and 2008, capital flows had reached around over 9 per cent of GDP when current account deficit was only around 1 per cent of GDP."
While a record $24 billion FIIs poured in in the equities market this year so far, the increased forex also helped in financing of current account deficit, which widened to 3.6 per cent of GDP in the first quarter of the financial year.
However, the Governor warned of possible intervention if these inflows become unmanageable.
"Large capital flows beyond the absorptive capacity of the economy could pose a major challenge for exchange rate and monetary management," he said.
He added: "Given the weak recovery, some advanced economies are in the process of resorting to another round of quantitative easing that could trigger capital flows into emerging markets, including ours."
"We want to finance our high current account deficit with these capital flows, and therefore, our task is to balance out these flows with our current account deficit," Subbarao said.
The Governor further argued, "While the ultra-loose monetary policy of advanced economies may benefit the global economy in the medium-term, in the short-term, it will trigger further capital inflows into emerging markets and put upward pressure on global commodity prices."
So far these inflows have been able to help us balance our current account deficit, which if further widens due to a larger import-export gap will be a cause for concern and will be difficult to sustain, he said.
"If the current trend persists, current account deficit as a percentage of GDP will be significantly higher than in the previous year," Subbarao said, adding "therefore our challenge is to rein in the deficit over the medium-term and finance it in the short-term."
Current account deficit is the gap between the amount the country pays to other countries against what it receives from abroad, barring capital movement.
Therefore the short term task of RBI is to see that "the current account is fully financed while ensuring that capital flows are not far out of line with the economy's absorptive capacity and that the component of long-term and stable flows in the overall capital flows is high", he said.
He pointed out that it's been often argued that widening of interest rate differential between the domestic and global markets will result in increased debt-creating capital flows.
"While it is true that large interest rate differential makes investment in domestic debt instruments and external borrowings by domestic entities more attractive, we need to keep in view three aspects in the domestic context," he said.
In its monetary review, the RBI said the foreign exchange market, which witnessed a significant increase in net inflows beginning September 2010, has remained orderly with the rupee showing two-way movements in the range of 44.03–44.74 per US dollar during October 2010.
Till October 22 this fiscal, the rupee had appreciated by 0.4 per cent on the basis of trade based 36-currency real effective exchange rate (REER), the central bank said.
The extent of appreciation was, of course, higher on the basis of 6-currency trade based REER (3.1 per cent) reflecting both the nominal appreciation of the rupee against the US dollar during this period and higher inflation differential with major advanced countries.
Since the 36-currency REER includes the currencies of many countries which are India’s direct competitors in the global market, it is a better reflection of the impact of global exchange rate movements on competitiveness, it added.
