SEARCH

Business

Updated: October 28, 2010 16:41 IST

Controlling forex flow could fuel inflation, warns RBI

Special Correspondent
print   ·   T  T  
Dr. D Subbarao,RBI Governorspeaks during an international conference organised by ICRIER on 'Policies for Growth and Financial Stability Beyond the Crisis' in Mumbai on Wednesday.
Business Line
Dr. D Subbarao,RBI Governorspeaks during an international conference organised by ICRIER on 'Policies for Growth and Financial Stability Beyond the Crisis' in Mumbai on Wednesday.

"The biggest problem thrown up by capital flows is currency appreciation which erodes export competitiveness. Intervention in the forex market to prevent appreciation entails costs," Dr Subbarao said.

Intervention in the foreign exchange market to stem the rise of the rupee due to capital inflows entails costs, Reserve Bank of India Governor Subbarao said here on Wednesday.

Addressing a conference on ‘Policies for growth and financial stability beyond the crisis — the scope for global cooperation,' organised by ICRIER, the German Development Institute (DIE) and InWent, here, Dr. Subbarao said “if the resultant liquidity is left unsterilized, it fuels inflationary pressures. If the resultant liquidity is sterilized, it puts upward pressure on interest rates which, apart from hurting competitiveness, also encourages further flows.”

The multi-speed recovery around the world and the consequent differential exit from accommodative monetary policy had triggered speculative capital flows into emerging market economies (EMEs).

“The biggest problem thrown up by capital flows is currency appreciation which erodes export competitiveness,” said Dr. Subbarao.

The rupee witnessed sharp appreciation against the U.S. dollar since September 2010. While the International Monetary Fund (IMF) recently warned EMEs of huge capital inflows, which could create financial instability, Yi Gang, Vice Governor of the People's Bank of China, too reacted by saying that controls on capital may be justified to stem such risks, but the controls also carry costs.

Dr. Subbarao said that managing currency tensions would require a shared understanding on keeping exchange rates aligned to economic fundamentals, and “an agreement that currency interventions should be resorted to not as an instrument of trade policy but only to manage disruptions to macroeconomic stability.”

Further Dr. Subbarao said emerging and developing economies did need capital flows to augment their investible resources, but such flows should meet two criteria: they should be stable and be roughly equal to the economy's absorptive capacity. The second reality that “we must remember is that capital flows are triggered by both pull and push factors.”

The pull factors are the promising growth prospects of EMEs, their declining trend rates of inflation, capital account liberalisation and improved governance.

The push factors are the easy monetary policies of advanced economies which create the capital that flows into the EMEs.

“What this says is that international capital flows comprise a structural component and a cyclical component.

“It is the cyclical component that typically causes all the adjustment problems for EMEs.”

“Speculative flows on the lookout for quick returns can potentially lead to asset price build up,” said Dr. Subbarao, adding that the assurance of advanced economies to keep interest rates ‘exceptionally low' for ‘an extended period' had also possibly triggered financialisation of commodities leading to a paradoxical situation of hardening of commodity prices even as advanced economies continue to face demand recession.

More In: Business | Economy

Commodity prices

Take a look at the prices of various commodities in Chennai here»

Instagram

O
P
E
N

close

Recent Article in Business

Hearing negatives about Bengal, says U.S. expert

Rick Rossow, questions Chief Minister Mamata Banerjee’s ostensible reluctance to engage with the United States (US) unlike her counterpart in Assam or Andhra Pradesh »