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RBI’s forex intervention spurs debate

Policy makers are examining options to narrow down the gap between rising foreign capital inflows and the current account deficit in the wake of an unprecedented appreciation of the rupee, reports Gaurav Choudhury.

business Updated: Sep 25, 2007 00:05 IST
Gaurav Choudhury

Policy makers are examining options to narrow down the gap between rising foreign capital inflows and the current account deficit in the wake of an unprecedented appreciation of the rupee, which has hit a nine-year high.

In India the net capital inflow has been much larger than required to finance the current account deficit, forcing the Reserve Bank of India (RBI) to intervene by buying out foreign currency assets.

The trend is quite similar to those in many other emerging Asian economies and officials indicated that policy makers were engaged in a debate on how far the central bank’s intervention could be justified in the current context.

The authorities might also be considering sterilisation of capital flows beyond $25 billion. The expansion of money supply would be the key determinant for the appropriate level beyond which foreign capital absorption would have to be sterilised by purchasing dollars and squeezing domestic liquidity.

“The $25-billion level is based on the assumption of a 17.5 per cent money supply growth,” officials said.

In 2006-07, the excess of capital inflows was five times the size of current account deficit. “If the excess of capital inflows over the current account deficit had been less than 50 per cent, it would have involved absorption and monetisation of about $5 billion. However, in the current context, the magnitude of monetisation required is much greater,” they added.

The government is not averse to imposing more stringent monitoring of short-term debt and restricting their end-use.

The opinion within official circles is that a “very large” proportion of ECBs raised by Indian corporates may still be circumventing the end-use norms.

Another option, officials said, is to liberalise outflows by removing administrative and procedural impediments.

The Prime Minister’s Economic Advisory Council (EAC) is of the opinion that simply curbing intervention was not the solution; the underlying imbalance between the current account deficit and foreign capital inflows need to be addressed.