The central bank has warned that any intervention in the currency market to dampen the appreciation of the rupee bears a cost. “Managing currency rates in the face of volatile flows entails costs, no matter what you do. The challenge is to minimise this cost,” said Reserve Bank of India Governor D Subbarao, while addressing a seminar here on Wednesday.
“We have to manage the impossible trinity at the national level,” he added, referring to the demands of keeping interest rates, the exchange rate and inflation at even keel.
The Indian currency has strengthened by nearly 6 per cent against the dollar since September, pumped up on foreign inflows totalling $11.7 billion, lured in part by Coal India’s record Rs 15,000-crore initial public offering. This year, foreign inflows into equities have touched a record $24.7 billion. In 2009, the net equity portfolio inflows stood at $17.5 billion.
Buying dollars adds liquidity to the banking system, which, in turn, aggravates inflation. Sterilising this liquidity could push up interest rates, thereby attracting further inflows, Subbarao explained.
“Managing currency tensions will require a shared understanding of keeping the exchange rates aligned to economic fundamentals, and an agreement that currency interventions should be resorted to not as an instrument of trade policy, but only to manage disruptions in macroeconomic stability,” he said.
Near-zero interest rates in developed markets have sent a flood of funds to higher-yielding emerging markets in search of higher returns, thus exerting upward pressure on their currencies and prompting several countries to impose capital controls.
However, Subbarao said emerging economies needed these capital flows, but they need to be stable and equal to the absorptive capacity of these economies. Managing capital flows was not a problem of emerging markets alone, he said.
“In as much as lumpy and volatile flows are a spill over from the policy choices of advanced economies, the burden of adjustment has to be shared,” Subbarao said.
He also said that it was unrealistic to expect emerging market economies to carry the full burden of lifting global growth. The sharp appreciation in the currencies of most emerging economies and unprecedented interventions by some countries has kicked off a debate among G-20 policymakers.
At the recently concluded G-20 meet, member nations agreed to refrain from competitive devaluation of their currencies. Subbarao said a theory encompassing current and capital account management was required, thereby explaining the efficacy of capital controls. He noted that in addition to country-specific measures, G-20 leaders had stressed on global solutions to current economic problems.
“Over an entire cycle, the economic prospects of emerging market economies remain firmly coupled with those of advanced economies,” Subbarao said. “The crisis has showed that in the event of deepening economic imbalances, uncoordinated responses will lead to worse outcomes for all of us.”
The rupee closed on Wednesday at Rs 44.45 to a dollar, against its previous close of 44.44.
