Raghuram Rajan :Challenging task to Control the Considerable capital flow
With the Indian economy forecast by the International Monetary Fund to be the fastest growing in the world, there is little doubt portfolio investors and multinational corporations would pour billions of dollars into India. That could be a problem of plenty rather than a painkiller, as it was in the past. A glance at the 170 countries’ currency exchange rate feed on the Bloomberg terminal shows just two nations’ currencies being stronger than the Indian rupee, Solomon Islands’ dollar and Somalia’s schilling. That should worry Reserve Bank of India governor Raghuram Rajan.
Add monetary easing by the European Central Bank, the Bank of Japan’s everlasting low interest rates and the falling US yields, and India faces a wall of money. Is not accelerated fund flow good for an economy that is starved of funds to build infrastructure and employ millions getting out of universities? Not necessarily.
“The RBI is likely to face a challenging external environment in the coming months, with considerable capital flow and currency volatility resulting from the divergent policy stances of the major advanced economy central banks,” says Eswar Prasad, Tolani Senior Professor of Trade Policy at Cornell University. “The RBI can best contribute to the stability of capital flows, exchange rates and growth by staying focused on its objective of low and stable inflation, in tandem with financial stability.
India received a record $40.32 billion from international institutional investors in both debt and equity in 2014. This year, the inflows have been $2.2 billion so far in debt and equity. It is this flow based on optimism about India that’s led to the rupee gain almost 2 per cent in relation to the US dollar. The rupee trades at 61.69 to the dollar. Although the appreciation can be a boon to over-leveraged companies with US dollar debt, it could throw a wrench in the country’s ambition to become a manufacturing power house.
“Given an annual BoP (balance of payments) surplus of $60 billion and consequent rise in RBI’s forex reserves (up $70 billion over the past one year after adjusting for forward positions), there could be a need to sterilise excess liquidity arising from the same,” says Ronini Malkani, economist, Citigroup. “Sterilisation tools that could come into play include Open Market Operations sales, MSS issuances and possible use of the cash reserve ratio.”
In this world of beggar-thy-neighbour policy, where most countries are attempting to benefit from a depreciating currency, the belief that a central bank could succeed in currency management could be dangerous, as the Swiss National Bank found out. The SNB last week abandoned its 1.20 to the euro ceiling roiling markets.
If the weak global macro economy results in continued easy monetary policies, it could well be deja vu for India, intervene to prevent sharp currency appreciation, then sell bonds in the name of Market Stabilisation Scheme, or use interest rate as a tool to manage the currency than just inflation.
Source:Economictimes
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