Managing capital inflows will be a big challenge: RBI

Managing capital inflows will be a big challenge: RBI
The Hindu Business Line, November 11, 2009, Page 4

Premature exit from expansionary policy can derail fragile growth: Shyamala Gopinath.


Our Bureau, Mumbai

The Reserve Bank of India is concerned about the volatility of capital inflows and its impact on the financial stability of emerging economies like India.

With India expected to tighten rates ahead of other countries, there is a possibility that the country will face a deluge of inflows due to the higher interest rate differential.

“Capital flows have resumed on the promise of India’s growth prospects. Under this backdrop, problems associated with a synchronous tightening of monetary policy, viz., exit from the expansionary policy earlier than others, can be especially relevant for emerging market economies like India. Here again one has to manage the trade off between the costs and benefits to the economy and that of preserving financial stability,” said Ms Shyamala Gopinath, Deputy Governor, RBI, while addressing the third India-China Finance Conference, here on Tuesday. Last year, following the global financial crisis, the Indian market had witnessed large-scale withdrawals by foreign institutional investors. However, from January this year, the FIIs have been net investors to the tune of $13 billion.

In fact, the capital account balance turned negative during the third quarter of 2008-09, the first time since the first quarter of 1998-99, mainly due to net outflows under portfolio investment, banking capital and short-term trade credit.

She pointed out that most of the developed countries do not face an immediate risk of inflation unlike India, which is actively confronted with an upturn in inflation.

“There are emerging signs of underlying inflationary pressures. The inflation based on different Consumer Price Indices continues to remain stubborn at double digits and the prices of food articles and essential commodities in WPI increased substantially on year-on-year basis,” she said.

In the second quarter Review of the Monetary Policy, the Reserve Bank of India had revised the inflation projection upward to 6.5 per cent from 5 per cent.

She said the challenge for the central bank is to support the recovery process without compromising on price stability.

“Premature exit will derail the fragile growth but a delayed exit can potentially engender inflation expectations. The balance of judgment at the current juncture is that it may be appropriate to sequence the ‘exit’ in a calibrated way so that while the recovery process is not hampered, inflation expectations remain anchored,” she said.

Explaining the reasons for the fall in non-food credit growth to 4.3 per cent in the current financial year, Ms Gopinath said lower credit demand from the manufacturing sector, corporates getting easier access to non-bank domestic sources of funds and external financing at lower costs, and reduced borrowings from oil marketing companies has led to lower credit growth.

Speaking at the event, Dr Ma Delun, Deputy Governor, People’s Bank of China, said that the Chinese central bank will maintain an accommodative monetary policy while closely monitoring global economic developments.