Are the RBI moves to support the rupee enough?

Discussion in 'Economy & Infrastructure' started by ejazr, Jun 25, 2012.

  1. ejazr

    ejazr Stars and Ambassadors Stars and Ambassadors

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    RBI has announced some measures to improve Rupee stability. Among which includes the opening up of Indian debt market to Foreigners. Centre-Right may welcome the move as its about time and Swadeshi folks might protest against the new East India Company taking shape. Lets discuss the merits of the new proposals

    Views | Are the RBI moves to support the rupee enough? - Views - livemint.com

    There was a lot of buzz over the weekend about a policy blitz to bolster investor confidence in the Indian economy. The Reserve Bank of India (RBI) has made the first move. On Monday, the Indian central bank announced ta few policy changes that could help increase inflows of global capital into India and support the weakening rupee. First, foreign institutional investors will be allowed to buy $20 billion of government bonds, $5 billion above the current limit. Second, the residual maturity on $10 billion of these bonds can be three years rather than the earlier five. Third, the market for government bonds has been opened up to sovereign wealth funds, insurance funds, endowment funds, pension funds etc. Fourth, Indian manufacturing and infrastructure firms that have foreign exchange earnings can raise external loans to repay rupee loans.

    These moves are part of a process through which RBI has gradually opened up the Indian debt markets. India has traditionally been less keen on foreign debt inflows compared to equity inflows, and for good reason. Critics rightly ask whether policy makers are not playing with fire by gradually dismantling this category of capital controls.

    But there is a more fundamental issue as well. The latest RBI move is part of an attempt to quell pressures on the external account. India runs a large current account deficit that needs to be funded through inflows of foreign capital. Indian policy makers have been heavily focused on increasing such inflows.

    It is also time to look closely at the current account deficit as well, rather than just think about how to fund it. Fast-growing economies often run such deficits. The only time in recent years when Indian had a current account surplus is during the growth slowdown in the first years of this century. The question thus is not whether India should have a current account deficit but to ask what deficit it can sustain. It has often been said that India can comfortably run an external deficit of around 2.5% of gross domestic product, or around 1.5 percentage points lower than right now.

    A current account deficit equals the difference between domestic investment and savings. The structural way to reduce the deficit will be to either cut the investment rate or raise the savings rate. The former will worsen the slowdown. It would be far better to try increase the domestic savings rate, which has been slipping primarily because of the decline in government savings thanks to fiscal profligacy. But corporate savings too could be hit if balance sheets worsen. The risk to household savings comes from the possibility that families reduce their savings in an attempt to maintain their consumption levels in a time of high inflation.

    In other words, while the new moves announced on Monday may be a useful tactical response to the pressure on the rupee, the more strategic need is to raise the domestic savings rate through stronger public finances and lower inflation.
     
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  3. ejazr

    ejazr Stars and Ambassadors Stars and Ambassadors

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    A counter-point on the risks associated witht he RBI move

    Views | Lowering capital controls can sometimes be a bad idea - Views - livemint.com

    At a time when Indian policy makers are busy attracting short-term capital inflows to bolster the rupee, another Washington institution has served a warning about the dangers of reducing capital controls in some circumstances.

    In its new Global Economic Prospects published in June, the World Bank has said that capital flows pose challenges to macroeconomic policy when countries are operating at or close to full capacity. A sudden inflow of capital at such a time can exacerbate inflation in goods and asset markets.

    Indian industry is operating near full capacity, going by capacity utilization and inventory data published by the Reserve Bank of India, but the situation described by the World Bank is closer to what we saw in 2008, when the Reserve Bank of India led by Y.V. Reddy went against the prevailing global consensus and argued for a policy to control capital inflows that threatened to worsen overheated in the Indian economy.

    The warning sent out of the World Bank comes after the International Monetary Fund famously abandoned its strong opposition to capital controls in early 2011, when its economists argued that countries could be justified in erecting walls in some circumstances.

    Indian policy makers are playing with fire because of their recent attempts to pull in short-term capital to fund the current account deficit, a move that could make the economy vulnerable in case there are “sudden stops” in capital flows during a global crisis. What’s more, such policies have not had anything than a transitory effect on the value of the rupee. For example, the further opening up of the local bond markets to foreign capital in December 2011 offered only temporary respite to the Indian currency; it began sliding within a few months as new storm clouds gathered over Europe.
     
  4. Daredevil

    Daredevil On Vacation! Administrator

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    The better way to get foreign exchange is to issue NRI bonds with a maturity period of 10 years or so. That way there will be stability and no fear of pullback of capital inflow suddenly and at the same time reduce the current account deficit.
     

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