Saikat Chatterjee and C.J. Kurrien, Reuters
Mumbai: Central bank governor Yaga Venugopal Reddy said on Wednesday that the rupee’s rise to nine-year highs would not necessarily bring down inflation and may instead fuel demand.
Reddy said measures to allow more fund outflows, announced in a policy review on Tuesday, were a step towards capital account convertibility rather than an attempt to stem the rupee’s rise.
“It is not meant in any way to alleviate today’s capital flows problem or today’s exchange rate management. The liberalisation of outflows is part of the gradual liberalisation of the capital account,” he told reporters.
On Wednesday, the rupee strengthened through 41 per dollar for the first time since May 1998 as investors bet on continued capital inflows and that the central bank would not intervene for now to check its gains. It has risen more than 8% in 2007.
“The day before yesterday’s volatility is today’s flexibility,” Reddy said, when asked why the central bank has let the rupee rise sharply after buying $19.7 billion (Rs80,854 crore) through intervention to help stem its gains.
An official panel last year recommended that India should move towards a fuller float for the rupee in three phases ending in the 2010/11 fiscal year.
“In some ways the effect of the currency appreciation is to make imported goods cheaper,” Reddy said, but there was a risk of this spurring demand.
“If the demand goes up, is it going to solve your inflation problem?” he asked.
Recent monetary policy — the central bank has raised its main lending rate five times in the 12 months to March — has been “a successful balancing act”, Reddy said, adding he expected easing of supply-side bottlenecks to help bring inflation down to its medium-term objective of 4.0% to 4.5%.
Annual inflation as measured by wholesale prices is running at just above 6%.
In Tuesday’s policy review, the central bank said moves towards greater capital account convertibility might accelerate.
It proposed letting firms repay more foreign debt sooner and raised the aggregate ceiling for overseas investment by mutual funds.
It raised a limit for firms’ portfolio investment abroad and proposed a higher cap on their general overseas investment as well as cutting the interest rate ceilings on non-resident deposits.
The rupee is the best-performing Asian currency against the dollar so far in 2007 and has risen about 15% since hitting a three-year low of 47.04 last July.
— Additional reporting by Nandita Bose