Now, it146;s RBI146;s turn to tackle capital flows

After Sebi8217;s recent decision to put curbs on foreign inflows into the stock markets, now it is the Reserve Bank of India8217;s turn to announce some steps to tackle the huge capital flows...

After Sebi8217;s recent decision to put curbs on foreign inflows into the stock markets, now it is the Reserve Bank of India8217;s RBI turn to announce some steps to tackle the huge capital flows and the aftereffects. The RBI, which will unveil the quarterly monetary policy on Tuesday, is likely to give some firm indications on the capital flows front and the interest rate regime.

8220;The RBI has been grappling with the liquidity overhang for quite some time. It can raise the cash reserve ratio CRR to moderate liquidity in the system, but whether it will do this remains to be seen in view of the curbs on FII inflows and external commercial borrowings. The language that the RBI will use on capital flows and interest rates will be keenly observed and analysed,8221; said a senior official with a foreign bank.

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 8212; the rate at which the it lends funds to banks against securities 8212; 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 8212; over 90 a barrel 8212; are still giving concerns and the static domestic fuel prices don8217;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 8212; 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, 8220;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.8221;

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 8212; stock market, real estate and commodities 8212; 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

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8226; Cash reserve ratio may rise, but chances have come down

8226; Repo rate likely to be reduced by 25 bps

8226; Further capital outflow liberalisation likely

8226; High oil prices to keep RBI alert against inflation