RBI looking at ways to manage inflows

Gokarn’s comments come after FM says there is no need to restrict tide of foreign capital.

The Reserve Bank of India (RBI) may consider measures to deal with foreign institutional investor (FII) inflows, which are emerging as a potential threat, said the central bank’s Deputy Governor, Subir Gokarn, in Mumbai on Tuesday. His comments came a day after Finance Minister Pranab Mukherjee said there was no need for restrictions on foreign inflows, in an interview with a television channel.

FIIs have invested a record $19.9 billion in Indian equity this year, of which around a third has poured in since the start of September, thereby exerting an upward pressure on the rupee. Overseas funds bought $9.9 billion worth of Indian bonds in 2010. On Monday, the domestic currency strengthened to a five-and-a-half-month high on sustained foreign portfolio investments and gains in other regional peers.

“It is becoming a larger global problem because of the imbalance — there is so much of liquidity and the returns are skewed towards emerging markets,” Gokarn said at a seminar. “So, it is emerging as a potential threat and we are clearly thinking of ways in which we can deal with it.”

Planning Commission Deputy Chairman Montek Singh Ahluwalia on Monday said though the current account deficit is wider than expected, it could easily be financed and is not a cause for concern. The current account deficit has risen three times to $13.7 billion in the quarter to June, over the corresponding period of the previous year.

“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.

The senior central bank official also said policy-tightening efforts by RBI since January have moderated inflation, but it still remains above the comfort zone, and is a concern.

“The sharp deceleration (in inflation) in recent months may reflect the impact of monetary actions and gives us confidence that the inflation rate will moderate significantly by the end of the fiscal year 2010-11,” said Gokarn.

Since January, RBI has raised policy rates by 125-175 basis points, and banks’ cash reserves by 100 bps to 6 per cent. It expects headline inflation to come down to 6 per cent by March end.

Inflation, measured by the wholesale price index, declined to 8.51 per cent in August, from 9.78 per cent in July, but is significantly up from 0.31 per cent a year earlier.

“There are distinct signs of a deceleration in inflation over the past couple of months. The turnaround coincides with our expectation that inflation begins to respond to monetary action after a six-month lag,” Gokarn said.

The central bank reiterated that policy rates have been "normalised", and that RBI would now look at growth data and inflation before taking further measures.

In the mid-quarter review of monetary policy on September 16, RBI raised the reverse repo rate – the rate at which it borrows from banks -- by 50 basis points to 5 per cent and the repo rate – the rate at which banks borrow from RBI -- by 25 basis points to 6 per cent. It had said the motivation to raise policy rates purely from a view to "normalise them" was over.

Gokarn defended monetary tightening in 2010 on the grounds that a continuation of an accommodative policy would have curtailed the central bank's capacity to respond to future shocks.

"The challenge, therefore, is to keep inflation in check over long periods of time, allowing the economy to grow at its potential rate with minimal disruptions and deviations," Gokarn said.