Mumbai: Former Reserve Bank of India (RBI) deputy governor Savak S. Tarapore on Tuesday said India must prepare itself for large capital outflows.
Tarapore also warned that the key rates of RBI should not be reduced as it would stimulate credit demand and aggravate the tight liquidity situation prevailing in the country. Any kind of capital controls should be market oriented, Tarapore pointed out.
As of 15 February, RBI’s foreign exchange reserve stood at $301 billion, higher by $110 billion from a year ago, largely due to capital account inflows.
However, the trend may not continue for long, as after being net buyers of about $17.5 billion in 2007, foreign institutional investors (FIIs) have turned net sellers of about $3.3 billion this year in Indian equities. According to International Monetary Fund’s World Economic Outlook (October 2007), there would be large portfolio outflows of $93 billion across the world in 2008.
To prepare for the capital outflows and avoid a “precipitous depreciation” of the rupee, Tarapore suggested monetary policy should not be eased but in the early stage of capital inflows tapering off, the RBI should aggressively buy in the forex market.
“Equally, when the outflow gathers momentum, RBI should be willing to sell forex to ensure that a stampede at the exit door does not result in a precipitous depreciation of the rupee,” Tarapore said. He was speaking at the launch of Dun and Bradstreet’s publication, India’s Top Banks 2008.
However, he said the injection of liquidity should be substantially less than the curtailment of liquidity as a result of forex sales by RBI, without disrupting the real sector activity.
The rupee has appreciated 12.5% against the US dollar in 2007. This year the trend has reversed and the local unit has so far depreciated more than 2.5% against the greenback.
Tarapore pointed out that in the case of India, where the forex reserve is entirely out of capital inflows, an appreciation of the rupee would be inappropriate as “it would merely widen the current account deficit and at some point foreign investors would be uncomfortable with the large current account deficit and an exodus of capital would snowball into a crisis situation.”
According to him, despite some signs of slowdown in the growth of the international economy, which would impact India as well, the country’s growth engine continues to show sufficient strength and it is reasonable to expect the economy to grow at a rate of 8.0-8.5% in 2008-09.
The Dun and Bradstreet publication, a collation of key data on Indian banks as on 31 March 2007, pointed out that notwithstanding the strengths of Indian banks, there are certain vulnerabilities. “Given the significance of scale in the global banking industry, too many banks sharing a low market share might lead to inefficiencies that could hinder sustained growth,” it said.
“While great advances have taken place in regard to technology absorption amongst public sector banks, issues of integration and networking across its universe of branch network remains a major challenge. Banks need to reinforce more focus in harnessing technology on its entire network of business and operations,” the publication said.