Reddy hints at more liquidity absorption on strong FII flows

Reserve Bank of India governor Y V Reddy on Thursday said absorption of liquidity by the central bank will likely increase because of strong inflows from foreign institutional investors.

Reddy said the RBI had enough tools to manage liquidity despite the strong capital inflows.

"Strong FII inflows are posing, to an extent, a great challenge, an additional challenge to the liquidity management. So, to the extent that we are planning liquidity unwinding...the amount we have to unwind may be more than we had anticipated," Reddy told reporters after a meeting of the RBI's central board here today. Foreign fund investments into India have been at a record high this year.

From January 1 till December 13, FII investments into India were at $8.6 billion. The inflows were at $7.7 billion in 2003. Reddy said he expected inflation to moderate slowly over a period of time.

"It (wholesale price index inflation) has been over 7 per cent over a period of time. It should moderate slowly but not very quickly. And we are hoping the year will end as we expected in the policy," Reddy said.
In its mid-year review of the 2004-05 Annual Policy late in October, the RBI had estimated March-end WPI inflation at 6.0-6.5 per cent. Since July, inflation has been hovering above 7.00 per cent.

Reddy said the overall sentiment on the economy was positive and the gross domestic product growth would be in the range as expected earlier.

"The overall sentiment is very positive. The growth of manufacturing industries is matter of particular satisfaction," Reddy said.

The RBI's policies had the intended impact on the financial and credit markets, Reddy said. On the impact of interest rate hikes by the US Federal Reserve, Reddy said there was no one-to-one relation between US and local interest rates.

"The impact on the market (of Fed's rate hike) was not dramatic as it was anticipated. And to some extent, this is in line with what we have captured in monetary policy stance," he said.

"There is no one-to-one link between Fed rate actions and our actions. At the same time, we keep a very close watch on such increases, particularly the Fed rate," he said.

"As you know, Fed rate hike has been discounted in some ways or already taken into account," he also said. On Tuesday, the US Federal Reserve hiked its target rate for federal funds by a quarter percentage point to 2.25 per cent. This was the fifth hike in 2004.