Good afternoon. There has been some turmoil in
financial markets across the world as fears of a sooner-than-anticipated Fed tapering have grown. In India, we
have had added volatility as the market has become
concerned about policy rates and about oil marketing
company demand for dollars.
There are issues we have to worry about and there are
issues we should not be so concerned about. It is
important that the RBI clarifies its interpretation of
economic events and the likely direction of policies at
times of uncertainty so that the market worries about
the right things and does not get into a tizzy about the
wrong ones. That is my goal today.
External Account
First, when the likely taper was announced in May,
markets focussed on India partly because of the large
size of its Current Account Deficit (CAD). The latest
trade data suggest we have made significant progress
in curbing the size of the likely deficit for this year.
I am especially happy about the 13.5 per cent increase
in dollar exports since last October, the reduction in
imports by 14.5 per cent and dramatic reduction in the
trade deficit by 48 per cent. Our estimate is that the
CAD for this year will be about US$ 56 billion, less than
3 per cent of GDP and US$ 32 billion less than last year.
Of course, some of that compression comes from our
strong measures to curb gold imports. One worry is
whether gold is being smuggled in sizeable amounts,
and is being paid for through the havala channel. While
we do see a sizeable increase in seizures, we believe
gold smuggling has increased from a low base, and is
still small.
A new worry that the market has latched on to is
whether the much diminished CAD can be funded
through capital inflows, given FII outflows. This is a
little bit like a dog chasing its tail, because a reason for
FII outflows is a worry about whether the CAD can be
funded. The only way to address such worries is to do
the math.
Last year FII inflows, both debt and equity, accounted
for US$ 26 billion. Let me assume that we get no inflows
this year, and in fact outflows equal the inflows we got
last year. In other words, there is a US$ 52 billion
turnaround in FII flows. Remember though that we
have US$ 32 billion less of CAD to finance this year,
and till yesterday, we raised US$ 18 billion of money
through new channels. So if other financing remains
the same as last year, which it seems on track for, even
if foreign investors pull out significantly more money
this year than they have so far, we still can break even
on capital flows.
Remember also that the major outflows in summer
were debt outflows. That money has not come back,
indeed our FII debt exposure, both corporate and
sovereign, has come down from US$ 37 billion on May
21 to US$ 19 billion today. I presume what is left is
more patient money, but given its diminished size, I
do not see its possible exit as a huge risk.
Note that all these calculations include meeting all the
demand from the oil marketing companies (OMCs) for
dollars! But still there are worries about what will
happen to the exchange rate if they are fully back on
the market. So let me turn to their demand. The
simplest way to think about this is that the RBI sold
dollars directly to oil marketing companies starting
August 28, 2013, thus ensuring they would not enter
the exchange market directly.
As the exchange market stabilised, we allowed oil
marketing companies to return and purchase more and
more dollars from the markets, starting on October 14.
Today, a month later, I am glad to report that the
majority of oil marketing company demand for dollars
is back on market. The market absorbed the additional demand quite smoothly – in fact, participants did not
even know it was back until some talk from the Finance
Ministry last week.
There has been some turmoil in currency markets in
the last few days but I have no doubt that once markets
calm down, the remaining demand will be absorbed
easily. We have no intention of rushing this process.
The OMCs have entered a swap arrangement whereby
they will have to repay dollars to the RBI on various
dates from February 2014 till April 2014. One worry
expressed by market participants is whether the OMCs
will add to further downward pressure on the rupee
when it comes time for them to repay dollars to the
RBI.
This to my mind is a non-issue because we have three
ways of managing the repayment. One is, of course, for
the OMCs to buy dollars in the market. If exchange
markets are calmer, this additional demand should be
absorbed. But if they are not calmer, we could roll over
some portion of the swaps so they mature at a calmer
time. But perhaps the easiest option would be for us
to settle the swap with the OMCs by making net
payments in rupees, and avoid the need for them to go
back to the market for dollars. When the time comes,
we will choose the most appropriate combination.
Domestic market
Let me turn from the external account to the domestic
market. Yesterday’s data suggested still weak growth
as the IIP numbers came below expectations. The earlier
core industry growth numbers suggested an incipient
recovery, and the IIP numbers have disappointed a
little, partly because of the volatile capital goods sector.
Nevertheless, I am still hopeful that the good monsoon
and the associated pick up in consumption, the very
healthy exports, and the strong growth in the power
sector should lead to stronger growth numbers for the
second half of the fiscal year.
Turning to inflation, the new CPI index came in at 10.1
per cent. Food inflation is still worryingly high, and the
effects of the harvest are still awaited. But looking
through the headline numbers, I am somewhat more
heartened by the outcome of core CPI inflation, which
declined to 8.1 percent from 8.5 percent in September.
The momentum for core inflation is also on the decline.
Markets are worried about what these data mean for
policy rates. As I have said before, the RBI is concerned
about the weak economy as well as high inflation. We
believe the weak economy, increases in food supply,
and recent policy rate hikes will provide a disinflationary
impetus over time, and recent data do not dispel this
view.
We will watch the incoming data carefully, especially
looking for the effects of the harvest on food prices as
well as the second round effects of fuel price increases
and exchange rate depreciation, before we make further
decisions on interest rates.
RBI to undertake OMOs for `8,000 crore on
November 18
Finally, the RBI is conscious of the need to keep the
system adequately supplied with liquidity, as we
indicated in a statement recently, so that productive
sectors are well supplied with credit. While borrowing
from the MSF facility has come down substantially after
the RBI extended the term repo window, market interest
rates suggest some liquidity tightness. To alleviate this
tightness, we propose to conduct OMOs. On next
Monday (November 18), we will undertake an OMO for
`8,000 crore.
Let me conclude. There is no fundamental reason for
volatility in the value of the rupee. We are left with fear
about what others will fear and do to explain what is
going on. At such times, it makes sense to take a deep
breath and examine the fundamentals. I hope you all
will do that.
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