| While inflation concerns have prevented the RBI from cutting interest rates, this may have exacerbated the problem. With the US Fed slashing rates by 75 bps (0.75 per cent), the interest rate differential between India and the US is now around 4.3 per cent, up from 1.5 per cent in April 2006 and around 2.5 per cent a year ago. As a result, the graphic shows, net capital flows have shot up, from 5 per cent of GDP in April 2006 to around 13 per cent in September 2007 and then falling to around 9 per cent in December 2007. Some argue the RBI didn't need to take action after the sharp Fed cuts as the rate differences were high anyway and so another cut would have a limited impact on inflows. Given how fund managers abroad can leverage their investments in interest-bearing securities (invest in G-Secs, use these G-Secs as collateral to get more to invest in G-Secs ...) and how the inflows make the rupee appreciate which, in turn, boosts their returns even more, it would be surprising if the inflows didn't pick up. And it is these inflows, as the RBI acknowledges, which have ensured that there is a liquidity overhang as money supply growth has outstripped credit growth. In others words, the problem may just have got worse. |
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