RBI estimates CAD for this year to be about $ 56 billion

Says there is no fundamental reason for rupee volatility

The Reserve Bank of India (RBI) governor, Mr Raghuram Rajan, said that there is no fundamental reason for rupee volatility. There has been some turmoil in financial markets across the world as fears of a sooner-than-anticipated Fed tapering have grown. However, domestically, the market is facing additional volatility as it has become concerned about policy rates and about oil marketing company demand for dollars. The RBI governor spoke after seeing the rupee fall for five straight sessions, and stepped in to steady frazzled nerves.

Speaking on the external front, Rajan said that the latest trade data suggest significant progress has been made in curbing the size of the likely current account deficit for this year. However he said, Some of that compression comes from our strong measures to curb gold imports. One worry is whether gold is being smuggled in sizeable amounts, and is being paid for through the havala channel. While we do see a sizeable increase in seizures, we believe gold smuggling has increased from a low base, and is still small.

On worries over funding the much diminished Current Account Deficit (CAD), he said that if other financing remains the same as last year, which it seems on track for, even if foreign investors pull out significantly more money this year than they have so far, we still can break even on capital flows. The RBI has estimated that CAD for this year will be about $ 56 billion, less than 3% of GDP and $ 32 billion less than last year.

The RBI sold dollars directly to oil marketing companies starting August 28, 2013, thus ensuring they would not enter the exchange market directly. However, as the exchange market stabilised, the oil marketing companies were allowed to return and purchase more and more oil from the markets, starting on October 14. After month later, the majority of oil marketing company demand for dollars is back on market. The market absorbed the additional demand quite smoothly.

The OMCs have entered a swap arrangement whereby they will have to repay dollars to the RBI on various dates from February 2014 till April 2014. This however may add to further downward pressure on the rupee when it comes time for OMCs to repay dollars to the RBI. Addressing this issue the RBI governor said that there are three ways of managing the repayment. One is, of course, for the OMCs to buy dollars in the market. If exchange markets are calmer, this additional demand should be absorbed. But if they are not calmer, RBI could roll over some portion of the swaps so they mature at a calmer time. But perhaps the easiest option would be to settle the swap with the OMCs by making net payments in rupees, and avoid the need for them to go back to the market for dollars. As the time demands the most appropriate combination will be chosen.

The governor raised concern over weak IIP growth. However, the good monsoon and the associated pick up in consumption, the very healthy exports, and the strong growth in the power sector should lead to stronger growth numbers for the second half of the fiscal year, said RBI.

The RBI said that the food inflation is still worryingly high, and the effects of the harvest are still awaited. But looking through the headline numbers, RBI sounded positive at the outcome of core CPI inflation, which declined to 8.1 percent from 8.5 percent in September and said the momentum for core inflation is also on the decline.

The weak economy, increases in food supply, and recent policy rate hikes will provide a disinflationary impetus over time, and recent data do not dispel this view, said RBI governor.

He further added We will watch the incoming data carefully, especially looking for the effects of the harvest on food prices as well as the second round effects of fuel price increases and exchange rate depreciation, before we make further decisions on interest rates.

RBI will keep the system adequately supplied with liquidity, so that productive sectors are well supplied with credit. While borrowing from the MSF facility has come down substantially after the RBI extended the term repo window, market interest rates suggest some liquidity tightness. To alleviate this tightness, it is proposed to conduct OMOs. On November 18, RBI will undertake an OMO for Rs. 8,000 crore.

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