RBI Act may be amended to tackle capital inflow

While sources in the know maintained that discussions were still in a preliminary stage, money market players were of the view that given the unabated forex inflows and the resultant dipping comfort level of RBI in managing the flow, issuing special securities could be a good idea to tackle capital inflows. In fact, this is in practice in a few countries. There could be different ways of issuing securities. One idea could be to use these securities to fund the dollar buying activity, a treasury head with a bank pointed out.

In its Annual Report, the RBI hinted at innovation of products to tackle the capital flows. “While the capital flows brought about an easing of external financing constraint, they have also posed dilemmas for the conduct of monetary policy,” the report noted.

The annual report also added that “these operations could have several implications like quasi-fiscal costs, bidding up of interest rates domestically and possibly depriving the economy of the benefits of capital inflows. Therefore, sterilisation is essentially a means of buying time until macroeconomic policies can be put in place to nurture a durable absorption of the capital flows into productive investments and augmentation of capacity in the economy.” Net capital inflows increased to an average of $9.1 billion (Rs 35,354 crore) per annum in the second half of the ’90s from $5.8 billion (Rs 8,225 crore) per annum during the second half of 1980s. During the fiscal 2002-03 alone, the net capital inflows were at $12.6 billion.

Excess supply conditions in the foreign exchange market were reflected in continuous dollar purchases by the RBI and accretions to the foreign currency assets. The primary liquidity generated by this accretion to the net foreign assets (NFAs) was sterilised through active recourse to open market sales and repos under the liquidity adjustment facility. As a result, the net domestic assets (NDAs) of RBI declined to as low as 2.9 per cent of reserve money as end-March 2003.

Here a critical issue is the sustainability of sterilisation given the depleting stock of government securities. As on August 15, 2003, RBI had government securities worth Rs 83,131 crore, and 47 per cent of this is actually marketable. “The decline in the NDA to near-zero levels as a proportion to reserve money focuses attention on the limits being approached to full sterilisation and, therefore, on the future conduct of the monetary policy in the context of large and sustained capital imflows,” the central bank said in the report.