MG 667: Economic Environment and Policy Presented by: Vivek Jain(07927820) Atul Seksaria(07927839) Is RBI intervention Justified ?

Objective To understand the dynamics and complexity of policies pursued by RBI To relate learning of the class to practice

To understand the dynamics and complexity of policies pursued by RBI

To relate learning of the class to practice

Functions of RBI Acts as the Monetary Authority It is the regulator and supervisor of the financial system Manager of Foreign Exchange Issuer of currency Developmental role Related functions like a)Banker to Govt and b) Banker to banks

Acts as the Monetary Authority

It is the regulator and supervisor of the financial system

Manager of Foreign Exchange

Issuer of currency

Developmental role

Related functions like a)Banker to Govt and b) Banker to banks

Challenges before RBI Rupee Appreciation Forex Reserves Capital Account Convertibility Economic Growth v/s Inflation

Rupee Appreciation

Forex Reserves

Capital Account Convertibility

Economic Growth v/s Inflation

Rupee Appreciation The story so far

The story so far

Highlights Rupee is at a 9-year high against the USD In 2007 alone, INR has appreciated by more than 11% All export oriented industries suffering IT, Pharma, Commodities and Textiles 11,000 people were rendered jobless in the textiles/garment sector alone

Rupee is at a 9-year high against the USD

In 2007 alone, INR has appreciated by more than 11%

All export oriented industries suffering

IT, Pharma, Commodities and Textiles

11,000 people were rendered jobless in the textiles/garment sector alone

Steps taken by RBI to check appreciation of Rupee Heavy intervention in the currency market USD 3.7 billion increase in the week ended Sep 21,2007 The RBI drains liquidity by issuing bonds and treasury bills Inference The intervention would ensure that the Rupee does not undergo wild swings that would happen RBI’s absence

Heavy intervention in the currency market

USD 3.7 billion increase in the week ended Sep 21,2007

The RBI drains liquidity by issuing bonds and treasury bills

Inference

The intervention would ensure that the Rupee does not undergo wild swings that would happen RBI’s absence

Forex Reserve India has attracted inflows worth over $35 billion from all sources since early July this year. Financial markets continue to experience conditions of surplus liquidity India joined the elite group of world's five biggest holders of foreign exchange reserves as it added about $4.5 billion last week to take the kitty to $261 billion.

India has attracted inflows worth over $35 billion from all sources since early July this year.

Financial markets continue to experience conditions of surplus liquidity

India joined the elite group of world's five biggest holders of foreign exchange reserves as it added about $4.5 billion last week to take the kitty to $261 billion.

RBI Intervention RBI has mopped up over $30 billion Liberalized Forex Rules Volatility in the foreign exchange market exposes foreign exchange reserves to both operational and market risks. Depreciation in the value of any reserve currency

RBI has mopped up over $30 billion

Liberalized Forex Rules

Volatility in the foreign exchange market exposes foreign exchange reserves to both operational and market risks.

Depreciation in the value of any reserve currency

Inference Unchecked and untreated, this can have destabilizing effects on the economy. An act of faith in India’s strong growth story Should India Use Foreign Exchange Reserves for Financing Infrastructure

Unchecked and untreated, this can have destabilizing effects on the economy.

An act of faith in India’s strong growth story

Should India Use Foreign Exchange Reserves for Financing Infrastructure

Capital Account Convertibility Capital Account Convertibility (CAC) a monetary policy that centers around the ability to conduct transactions of local financial assets into foreign financial assets freely and at pre-set, fixed market rates allows the easy exchange of local currency (cash) for foreign currency at low rates Rationale behind RBI’s intervention: free mobility of capital leaves countries open to both sudden and huge inflows as well as outflows, both of which can be potentially destabilizing example: East Asian crisis in the late 90s phenomenon predominantly affects open economies - India today is in such a situation

Capital Account Convertibility (CAC)

a monetary policy that centers around the ability to conduct transactions of local financial assets into foreign financial assets freely and at pre-set, fixed market rates

allows the easy exchange of local currency (cash) for foreign currency at low rates

Rationale behind RBI’s intervention:

free mobility of capital leaves countries open to both sudden and huge inflows as well as outflows, both of which can be potentially destabilizing

example: East Asian crisis in the late 90s

phenomenon predominantly affects open economies - India today is in such a situation

RBI’s Intervention : Buildup of Forex reserves by another 150-200 billion USD before full CAC is possible removal of structural bottlenecks introduction and diversification of new players and instruments introduction of new technology improvement in trading infrastructure Inference : Going forward, in the face of further liberalization and fuller CAC, RBI intervention is in the monetary policy is the only way ahead

RBI’s Intervention :

Buildup of Forex reserves by another 150-200 billion USD before full CAC is possible

removal of structural bottlenecks

introduction and diversification of new players and instruments

introduction of new technology

improvement in trading infrastructure

Inference : Going forward, in the face of further liberalization and fuller CAC, RBI intervention is in the monetary policy is the only way ahead

Economic Growth V/S Inflation (CRR HIKE) HIGHLIGHTS Inflation was spiraling out of control Had crossed 6% levels in the previous fiscal year In a developing economy, this was expected since a lot of money supply is needed to fund projects. That leads to inflation according to the quantity theory of money Banks had been cutting rates on new loans in order to improve credit off take USD 62 billion has been added as forex reserve in this FY of which USD 48 billion has been in the last 4 months

HIGHLIGHTS

Inflation was spiraling out of control

Had crossed 6% levels in the previous fiscal year

In a developing economy, this was expected since a lot of money supply is needed to fund projects. That leads to inflation according to the quantity theory of money

Banks had been cutting rates on new loans in order to improve credit off take

USD 62 billion has been added as forex reserve in this FY of which USD 48 billion has been in the last 4 months

RBI intervention RBI hiked the CRR in phases gradually to 7.5% This led to suction of about INR 71,000 crores from the financial system of the country Banks preferred lending money to people/corporations with proven credit-worthiness As a result, money available for borrowing decreased Gradually this led to a sharp fall in inflation as well !

RBI hiked the CRR in phases gradually to 7.5%

This led to suction of about INR 71,000 crores from the financial system of the country

Banks preferred lending money to people/corporations with proven credit-worthiness

As a result, money available for borrowing decreased

Gradually this led to a sharp fall in inflation as well !

Inference The timely intervention by RBI helped suck excess liquidity from the system RBI also encouraged overseas investors to buy stocks and bonds to the tune of another 74,800 crores The move has ensured that the banks do not further lower their lending rates Most important, Inflation has dropped to below 3% for the first time in 5 years !!

The timely intervention by RBI helped suck excess liquidity from the system

RBI also encouraged overseas investors to buy stocks and bonds to the tune of another 74,800 crores

The move has ensured that the banks do not further lower their lending rates

Most important, Inflation has dropped to below 3% for the first time in 5 years !!

Former RBI Governor Dr. Bimal Jalan said at a forum once: “ The East-Asian crisis has demonstrated the vital importance of financial institutions in sustaining the growth momentum and development. It was no longer possible for developing countries to delay the introduction of strong prudential and supervisory norms, and introduce structural reforms to make the financial system more competitive, transparent and accountable. ”

“ The East-Asian crisis has demonstrated the vital importance of financial institutions in sustaining the growth momentum and development. It was no longer possible for developing countries to delay the introduction of strong prudential and supervisory norms, and introduce structural reforms to make the financial system more competitive, transparent and accountable. ”

Thank you!

Thank you!