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RBI On Forex Rates and CRR Hikes


I wrote at Yahoo about "Why Only Interest Rates?" (Will post article tomorrow). I just noticed that the RBI released an audio recording of a post-policy teleconference.

A question was asked: Rise in rates will result in appreciation in currency. Will RBI allow that? Will imported inflation reduce?

Answer from RBI: we don’t intervene in forex markets with the objective of setting interest rates. To the extent that we have intervened it is to offset volatility. If there is an inflow from interest rate arbitrage, we won’t intervene. Yes, if currency moves up it will reduce imported inflation and curb demand.

We haven’t seen a big change in the forex rates, and Current Account Deficit is kinda-sorta matched by the Capital inflows. Yes, a rate appreciation would help but even when there is a relatively open capital account.

My take: I’ll believe it when I see it (that RBI won’t intervene). But yes, they seem to have not really intervened in the markets directly recently (though reserves have risen). Will they continue to NOT do so if the rupee sees 40?

Second, we don’t have a "relatively open capital account". People aren’t allowed to hold rupees outside India, foreigners aren’t allowed to buy our traded debt (government or private), we aren’t allowed to go abroad and raise large amounts of money. The statement is like saying tigers are very calm inside a cage. Of course we’re calm, there’s no wiggle room!

Question: Wouldn’t it be useful to change CRR?

Answer: We have to distinguish between liquidity and demand control. Liquidity is the basis on which a financial institution would expand credit. In that context liquidity is in a deficit since May 2010. Given that, we don’t see any significant benefits with moving up CRR, which could also be disruptive because of uncertainties in cash availability. Transmission from policy to lending rates is strong – we saw banks moving up rates nearly immediately.

My take: I don’t really agree. First, disruptive is a strong word; but it does help to have liquidity taken out of the system, in any case. Repo rates work the demand situation; that is, they reduce customer demand for credit. But they don’t really make banks want to lend lesser, or worry about their capital ratios, which is what needs to be promoted if credit growth needs to really moderate. A 0.5% hike in CRR would have taken out just Rs. 25,000 crore from the system, which would then have to be borrowed at the 8% rates, keeping banks in check better.

(I’ve phrased it my way)


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