RBI wants more focus on capital flow quality

FM to meet RBI chief to discuss foreign capital inflow issues.

The Reserve Bank of India (RBI) has called for a shift in the manner in which foreign investment policies are managed to ensure there are broader measures in place to block undesired capital inflows and to enhance the quality of flows.

The central bank wants the government to adopt a more holistic approach that combines sectoral regulations with broader measures to enhance the quality of flows and make the source of inflows transparent.

In its quarterly review of monetary policy, RBI said "it is critical for public policy (government) to effectively, demonstrably and convincingly indicate commitment to management capital flows consistent with macro fundamentals through appropriate and decisive policy actions."

Finance Minister P Chidambaram said RBI Governor Y V Reddy is likely to meet him when he visits New Delhi to discuss issues about controls on foreign capital inflows.

The challenge is also to meet unexpected turn of events as was seen in the third week of January. The volatility in the market showed the potential for reversal in capital flows, the central bank said.

RBI has outlined in its policy review that several central banks have confronted volatile and large capital inflows through monetary tightening measures involving either hike in policy rates or hikes in reserve requirements or both.

While China raised the reserve requirement from 8 per cent to 15 per cent, the Bank of Korea hiked it from 5 per cent to 7 per cent after a gap of 17 years. Thailand imposed unremunerative reserve requirements of 30 per cent on most capital inflows which is to be deposited with the central bank for one year.

Earlier, RBI had raised concerns on inflows through the offshore derivative route of participatory notes into the capital market.

Thereafter, it had suggested several measures to curb inflows through the private equity route by having lock-in periods and sectoral caps to restrict the inflows into undesired sectors like real estate. Similar curbs were also enforced for restricting inflows through the venture capital fund route.

RBI has observed that the Securities and Exchange Board of India has modified the registration criteria for foreign institutional investors by broadbasing the norms, thus limiting the issuance of participatory notes or offshore derivative instruments.

However, these measures could not curb the volatility in the portfolio flows (FII) resulting in large movements in stock prices.

In 2007-08, the government in consultation with RBI curbed the inflows through the external commercial borrowing route (ECB) by restricting the use of foreign exchange capital for rupee expenditure.

Till January 11, portfolio inflows amounted to $26.8 billion compared to $2.5 billion for the same period in FY07.