Capital flows pose a challenge: RBI

While acknowledging the prospects of large capital flows, Reserve Bank of India Governor D Subbarao has said these pose a challenge for exchange rate and monetary management.

In his address at International Monetary Fund’s meeting in Washington on Saturday, the governor also said reserve accumulation is a very important element of financial safety net, especially in countries that had built them in the context of current account deficits to deal with inherently volatile capital flows.

Subbarao said that capital flows can impair financial stability in emerging market economies (EMEs) due to the recent spurt in flows on the back of faster recovery, higher interest rates and better growth prospects in these economies. “The familiar question of how EMEs can maximize the benefits and minimize the costs of volatile capital flows has returned to haunt the policy agenda,” Subbarao said.

While pointing to the change in the debate on capital controls following the financial crisis, Subbarao also said that gradual liberalisation of the capital account was a better option given that “premature opening hurts”.

“Now that there is wide agreement that controls can be ‘desirable and effective’ in managing capital flows, IMF and other international bodies must pursue research on studying what type of controls and under what circumstances so that emerging economies have useful guidelines to inform policy formulation,” he suggested.

So far in 2010, foreign institutional investors have pumped in close to Rs 50,000 crore in debt and equity markets putting pressure on the rupee. While RBI intervenes in the market to check steep appreciation of the rupee it does not want to be too active as it will increase the availability of the rupee in the market when it purchases dollars.