RBI cautious about capital flows

RBI cautious about capital flows
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First Published: Tue, Jul 31 2007. 08 19 AM IST
Updated: Tue, Jul 31 2007. 08 19 AM IST
A day before the presentation of its quarterly review of monetary policy, the Reserve Bank of India (RBI) sounded a word of caution on capital flows.
In its report, Macroeconomic and Monetary Developments for April-June, the central bank said the conditions in the US subprime mortgage sector “have detoriated significantly” with delinquencies on the rise.
Further deterioration in sub-prime delinquencies could lead to abrupt rise in risk premium across markets and products, and such developments could lead to “greater volatility in capital flows to emerging market economies”.
Volatility, according to the banking regulator, can increase by the growing dominance of hedge funds in the volume of cross border flows.
The growth in activity of hedge funds is a cause of concern for regulators across the globe as these funds are “largely unregulated and governed by opaque investment partnerships”, it adds. RBI also warned against a possibility of private equity players pulling back inflows from India.
Assessing the key macroeconomic indicators among the emerging market economies, RBI said the real policy rates ranged in between 2% and 4% in June-July, while the real effective exchange rate (Reer), or the inflation-adjusted purchasing power of most currencies, remained high for most economies.
In India, the spot value of the rupee was 12% higher than its actual purchasing power. Reer is arrived at after comparing the rupee with a basket of currencies of other countries that are India’s largest trading partners.
On the domestic front, however, there is a note of optimism. The growth in bank credit, which has been a cause of concern for the regulator, “moderated” in the first quarter of 2007-2008 from the strong pace in the preceding three years. This is because RBI has aggressively made use of monetary tools to tighten liquidity. It has raised the reserve ratio that commercial banks need to maintain with the central bank and raised short-term interest rates.
The central bank also sucked out liquidity from the system with the help of issuances of securities under the market stabilization scheme.
The report states that “bank credit to the commercial sector exhibited some moderation”. Scheduled commercial banks’ non-food credit expanded by 24.4% year-on-year 6 July, compared with 28.4% atthe end of March and 32.8% a year ago.
With a slowdown in bank credit growth, the business confidence of corporations has witnessed a decline.
According to the Industrial Outlook Survey conducted by the bank during June, the business expectations index, based on assessment for April-June declined by 5.8% over the previous quarter. The business expectations index, based on expectations for July-September, declined by 3.0% over the previous quarter.
The indices, based on assessment and expectations, were lower by 4.9% and 4.3%, respectively, than a year ago.
The decline in the expectations index was on account of fall in net responses for most of the parameters of the survey such as overall business situation, production, working capital finance, order books, capacity utilization, exports, employment and profit margin.
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First Published: Tue, Jul 31 2007. 08 19 AM IST