The Reserve Bank of India in its mid-term review of annual policy announced on Tuesday kept interest rates unchanged, but hiked the cash reserve ratio (CRR), the money that banks park with the central bank, by 50 basis points to 7.5 per cent.
Having addressed the issue of containing inflation in its previous monetary policy reviews, the RBI said it was not domestic money supply or liquidity that was a major concern at the moment for the central bank, but surging capital inflows from abroad.
"There is a need for active capital account management in India," RBI Governor Dr YV Reddy said. In the current year, $62 billion has been added to the country's foreign exchange reserves of which $48 billion has come in since end-June 2007.
Portfolio flows or the money flow into share markets till October 19 has been $21.2 billion in financial year 2007-08, compared with just $0.9 in the corresponding period last year. "We also want financial markets to be prepared for unconventional responses from us to meet unanticipated and undefined global shocks," Reddy said.
Drawing attention to the risk emanating from a global credit market turbulence, Reddy said the possibility of a contagion, if at all any, would be through the equity and currency markets. The central bank's policy statement said: "The currency markets are affected through equity market players, or in the guise of equity market players. It is possible to take positions in equity even if the sole motive is currency speculation or carry trade."
The RBI governor reiterated central bank's stand in recommending a ban on participatory notes (PNs), an instrument that anonymous entities used to invest in Indian equities. "Our approach and our stand with regard to participatory notes is that they are not desirable," he said.
This is the best of times for investment and capital formation since independence with the most benign atmosphere, said Reddy. "We want this story to continue," he said, adding that the RBI would watch out for any disturbances that could affect growth and stability.