RBI considering ways of dealing with capital flows

RBI considering ways of dealing with capital flows

Mumbai: The Reserve Bank of India (RBI) is concerned over the heavy foreign capital flow into the domestic market, calling it a “potential threat", and saying that the regulator is considering ways of dealing with the excessive fund movement, even as inflation remains a concern.

“It (capital flows) is becoming a larger global problem because of the imbalance that there is so much of liquidity and the returns are skewed towards emerging markets," RBI deputy governor Subir Gokarn said at a private equity conference in Mumbai on Tuesday. “So it is emerging as a potential threat and we are clearly thinking of ways in which we can deal with it."

Foreign fund flows into domestic equities so far this year are at around $20 billion (Rs89,400 crore), with about one-third of that entering the market since the start of September, driving up stock prices and putting upward pressure on the rupee. The partially convertible rupee rose to 44.2525 per dollar on Monday, its highest in five months, before easing on Tuesday to 44.705.

“As long as the capital flows are in excess of the current account deficit, the pressure to appreciate will continue and it could potentially disrupt," Gokarn said.

India’s current account deficit widened in the June quarter from the previous three months to $13.7 billion.

Interestingly, RBI’s comments came shortly after finance minister Pranab Mukherjee said there was no need to intervene in the foreign exchange market or cap foreign portfolio inflows now.

“We are watching the inflow of funds. But I don’t think it’s time to put any restriction on it," Mukherjee said in an interview. “I feel we do not need to be panicky, but should be careful and cautious."

Noting that the apex bank is nearing the completion of its monetary policy normalization, Gokarn, however, added that high inflation, still hovering above the targeted level, remains a concern.

India’s headline inflation, after staying in double digits for five months since February, began easing and stood at 8.5% in August, but is still above RBI’s projection of 6 % by end-March.

Deepak Mohanty, executive director at RBI, said in a speech delivered at the Bankers Club, Chennai, late last month, that India needs to make appropriate policy responses to contain the high inflation.

“It is important to persevere with appropriate policy responses so that the high inflation seen in the recent months does not get entrenched. Even if the trigger for inflation is from the supply side, its persistence necessitates monetary policy responses to bring inflation rate back to its trend and anchor inflationary expectations," Mohanty said.

RBI is scheduled to announce its mid-term policy review on 2 November.

The central bank has upped its key policy rates five times this year, with the latest being on 16 September at its first ever mid-quarter review, when it had hiked its repo rate, at which it lends to banks, by 0.25 percentage point to 6%, and reverse repo rate, at which it borrows from banks, by 0.5 percentage point to 5%.

“The current inflation scenario is a cause of concern, as the inflation rate persists well above the upper bound of the comfort zone," Gokarn said.

The yield on India’s 10-year benchmark bond rose four basis points after the inflation comment to close flat at Monday’s level of 7.94%. In early morning trading, the yield had dropped to 7.90%. One basis point is one-hundredth of a percentage point.

Arvind Sampath, director, rates trading at Standard Chartered Bank, said Gokarn’s comments could be an indication that the banking regulator may be considering raising policy rates further in the upcoming review. “Post today’s comment on inflation, the bond market has begun repricing the chance that there would be a rate hike in November. The probability of that seemed lower with inflation stabilizing earlier. Since capital inflows are currently not disruptive, nothing specific is expected by the market, and the market was largely unaffected by the comments," Sampath said.

Anup Roy and Reuters contributed to this story.