Now, it’s RBI’s turn to tackle capital flows

With inflation coming down to 3 per cent, the RBI is likely to get some room for manoeuvring on the interest rate front. There is already demand from India Inc and a section of the banking sector for a reduction in rates. According to one school of thought, the RBI can start with a 25 bps cut in repo rate — the rate at which the it lends funds to banks against securities — in view of the fall in inflation.

Since September 2004, the repo rate and the reverse repo rate have been increased by 175 and 150 basis points respectively, while the cash reserve ratio has been raised by 200 basis points as part of the monetary tightening by the RBI. However, the high oil prices — over $90 a barrel — are still giving concerns and the static domestic fuel prices don’t reflect the soaring global prices. But the rise in the rupee value has given some relief to the oil companies.

On the other hand the US Fed, which cut rates by 50 bps last month, is expected to cut rates at its meeting on October 31. This might change the scenario as far as global capital flows are concerned. India witnessed a huge inflow after the September rate cut by the Fed. As a result, the RBI has been mopping up excess dollars from the system — estimates are that the RBI mopped up over $20 billion from the market in the last two months alone, taking the forex reserves to the $ 261 billion mark. It has been sterilising the system and has hiked the market stabilisation scheme (MSS ) last month.

RBI deputy governor Rakesh Mohan said in a recent speech, “In this environment, leaving the exchange rate to be fully determined by capital flows can pose serious setbacks to exports and, over time, external sector viability. Indeed, as the Asian financial crisis showed, real appreciation can lead to future vulnerability and avoidable volatility in the economy. Thus, like other central banks grappling with the impossible trinity, the Reserve Bank has been operating in an intermediate regime.”

According to bankers, the RBI is also likely to come out with further liberalisation of policies in regard to capital account outflows. It had recently hiked the maximum amount an individual can take out of the country to $2 lakh a year from $1 lakh a year. The RBI had also raised concerns about rising asset prices — stock market, real estate and commodities — in the earlier policies. As asset prices have not showed any signs of decline, the RBI observations on this front, too, will be closely watched.

POLICY EXPECTATIONS

• Cash reserve ratio may rise, but chances have come down

• Repo rate likely to be reduced by 25 bps

• Further capital outflow liberalisation likely

• High oil prices to keep RBI alert against inflation