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Monetary Policy: Steps towards convertibility - Views on News from Equitymaster
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  • Apr 24, 2007

    Monetary Policy: Steps towards convertibility

    It is wonderful how we Indians take big steps when push comes to shove. We do not know whether it is a bid to reduce the need for Reserve Bank's intervention in the foreign currency markets to keep the Rupee from appreciating or if it is the confidence in the nest egg of US$ 203 bn that the RBI has amassed over the last few months. But finally in its annual policy statement released today, the RBI is allowing Indians and Indian entities to have freer access to dollars and overseas financial markets.

    Thankfully, the Reserve Bank of India (RBI) seems to have woken up to the perils of containing the Rupee appreciation at the cost of the domestic economy. It has tried to reduce pressures exerted by the NRI deposits (US$ 3.2 bn between April and December 2006 as compared to US$ 0.3 bn in the same period in 2005), by reducing the ceiling on FCNR (B) deposits as well as on the NR(E)RA deposits by 50 basis points each.

    Instead of itself buying the excess of dollars in the forex markets, the RBI has now allowed a limited role for the market forces by making it easier for Indians and Indian entities to spend in dollars, treading carefully towards complete capital account convertibility.

    Opening up the sluice gates

    Indians can now send US$ 1,00,000 to their children settled abroad, instead of US$ 50,000. Indian mutual funds can invest US$ 4 bn, up from $3 bn, in international markets. Overseas investment limit for Indian companies has been enhanced to 3 times its net worth from the present limit of 2 times. Pre-payment limit of ECBs improved to US$ 400 m from US$ 300 m (but with domestic rates so high, not many corporates would oblige).

    Greater role is given to the authorized dealers in deciding the worthiness of any obligation that would send dollars out of the country for legitimate business expenses - easier times for BPO operators, oil explorers, consultancy services, commodity traders, etc.. Individuals are also allowed to book forward contracts without the underlying documents up to US$ 100,000.

    Wheels in motion for unchartered territories

    There is also some background noise on bettering the financial markets, and better reporting for better monitoring of capital inflows. A lot of working groups are to be set up to study interest rate futures markets, currency futures - all necessary to have a regulated financial scenario if and when the RBI decides to take up Mr Mistry and his friends' suggestions on making 'aamchi' Mumbai fulfill the gap between London in the west and Singapore in the east.

    On a more mundane level..

    The RBI has outlined its hopes on all the nitties and gritties that make up headlines nowadays; the money supply growth, credit offtake, 'comfortable' rates of inflation. All that goes in to decide how dear money will be over the next few months. As the 30th March 2007 CRR hikes had already contained the reserve money growth from a galloping 23.7% (before the March 2007 CRR hike) to a more respectable 18.9% as compared to 17.2% in March 2006, the RBI has left the various credit control measures at its disposal unchanged.

    The alerts!

    Inflation should stay close to 5% in the near future and slide down to 4% to 4.5% by the end of the fiscal year. To target this rate, broad money can grow between 17.0% to 17.5%, non-food credit by about 24% to 25%, and deposits too ought to go up by robust Rs 4,900 bn (has grown by Rs 4,852 bn or 23% YoY as on 31st March 2007). If any of these numbers do not come through, the RBI will have to take charge once again. Any slower and GDP growth of a targeted 8.5% will not come through, and any higher, the interest rates will be raised again.

    As the central bank reiterates, it has not taken any recourse to the Bank rate that has stayed at 6% through all these CRR and repo rate hikes. The longer-term yields have not hardened as much as at the shorter maturity - flattening the yield curve. Thus, it hopes that the growth rates would not be seriously impacted by the liquidity mop-up exercise of the last few months.

    Right prescriptions for the future

    We believe, however, that the GDP would grow in the range of 7.5% to 8.0% for FY08 with inflation tapering from a 6% range to around 5% by the last quarter of FY08, barring further rate hikes and a decent monsoon. A slowing US economy could see the US fed rates reducing, weakening the dollar further, and increasing money supply in India through more money leaving the US to find greener pastures. This should just nudge the RBI closer to fuller convertibility on the capital account.



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