RBI INTERVENTION Group 9B By Lakshmi Priya .A (07927817) Mohit Bansal(07927952 ) 05/28/09 Against RBI Interventions

Outline Introduction Current Rates How does the RBI interfere What the RBI is trying to control Methods of intervention Effects of intervention Conclusion

Introduction

Current Rates

How does the RBI interfere

What the RBI is trying to control

Methods of intervention

Effects of intervention

Conclusion

INTRODUCTION Monetary policy - Management of money supply and interest rates by central banks to influence prices and employment Expansion or contraction of investment and consumption expenditure.

Monetary policy - Management of money supply and interest rates by central banks to influence prices and employment

Expansion or contraction of investment and consumption expenditure.

Current policy rates Bank rate: 6 Repo 7.75 Reverse repo : 6 Reserve ratios CRR: 7 SLR: 25 Lending/deposit rates PLR: 12.75-13.25 Savings bank rate:3.5 Deposit rate: 7.5-9.6%

Current policy rates

Bank rate: 6

Repo 7.75

Reverse repo : 6

Reserve ratios

CRR: 7

SLR: 25

Lending/deposit rates

PLR: 12.75-13.25

Savings bank rate:3.5

Deposit rate: 7.5-9.6%

What RBI is trying to Control? Open capital account Pegged currency regime Independent monetary policy Impossible Trinity 05/28/09 Against RBI Interventions

Open capital account

Pegged currency regime

Independent monetary policy

Impossible Trinity

Confused states of the Trinity Inflation Rises - Contractionary Policy : To Decrease Money Supply Interest rates will go up . Open C apital account : Money from Abroad. Pressure on the rupee to appreciate. Central Bank buys up the dollars leading to Increased Money Supply. 05/28/09 Against RBI Interventions

Inflation Rises - Contractionary Policy

: To Decrease Money Supply

Interest rates will go up .

Open C apital account : Money from Abroad.

Pressure on the rupee to appreciate.

Central Bank buys up the dollars leading to

Increased Money Supply.

Another State of confusion US hikes the Fed rate Capital will flow out :Currency will depreciate. RBI to prevent depreciation: sell dollars or raise rates. Currency pegging forces RBI to also raise rates. Peg means following US monetary policy Autonomous Monetary Policy? 05/28/09 Against RBI Interventions

US hikes the Fed rate

Capital will flow out :Currency will depreciate.

RBI to prevent depreciation: sell dollars or raise rates.

Currency pegging forces RBI to also raise rates.

Peg means following US monetary policy

Autonomous Monetary Policy?

RBI’s Attempt to dodge this Trinity Sterilised Intervention: selling of bonds Constraints to sterilisation Run out of bonds Mounting fiscal costs The rates go up and this sucks in more capital flows Short term solutions 05/28/09 Against RBI Interventions

Sterilised Intervention: selling of bonds

Constraints to sterilisation

Run out of bonds

Mounting fiscal costs

The rates go up and this sucks in more capital flows

Short term solutions

Efficient Sterilization 05/28/09 Against RBI Interventions

Inefficient Sterilisation 05/28/09 Against RBI Interventions

RBI ran out of stocks of government bonds in May 2004, at the end of 2004. M0 is smaller than NFA(!). Monetary Stabilisation Bonds were started – but explicit fiscal cost; no longer the hidden costs of pegging. Forex intervention continued - endeavour to get exchange rate back under control. Greater globalisation requires bigger market manipulation - e.g. $12 billion in February 2007 alone. Only partly sterilised.

RBI ran out of stocks of government bonds in May 2004, at the end of 2004.

M0 is smaller than NFA(!).

Monetary Stabilisation Bonds were started – but explicit fiscal

cost; no longer the hidden costs of pegging.

Forex intervention continued - endeavour to get exchange rate

back under control. Greater globalisation requires bigger market manipulation - e.g. $12 billion in February 2007 alone.

Only partly sterilised.

CRR Increase of CRR of nearly 1% in 10 months

Increase of CRR of nearly 1% in 10 months

Used to reduce liquidity in the system Reduces the money available for credit . Turbulence in the call money markets due to sudden hikes in CRR

Used to reduce liquidity in the system

Reduces the money available for credit .

Turbulence in the call money markets due to sudden hikes in CRR

Repo rate : RBI lends money to banks – how the RBI influences interest rates . Reverse Repo rate : RBI pays to banks for their excess funds with RBI in form of Govt Securities -RBI increases R R wants to reduce liquidity. -Financial markets tighten and there is an increase in yields of securities. Banks tie interest rates to these yields. - Increase in lending and deposit rates.Less spending Bank Rate : rate at which RBI borrows from the bank

Repo rate : RBI lends money to banks – how the RBI influences interest rates .

Reverse Repo rate : RBI pays to banks for their excess funds with RBI in form of Govt Securities

-RBI increases R R wants to reduce liquidity.

-Financial markets tighten and there is an increase in yields of securities. Banks tie interest rates to these yields.

- Increase in lending and deposit rates.Less spending

Bank Rate : rate at which RBI borrows from the bank

Increase in Reverse Repo from 01-06

Effects of RBI Intervention Volatility in Exchange Rates 05/28/09 Against RBI Interventions

Volatility in Exchange Rates

Growth in Forex Reserves In 2006-07 reserve money growth rose to 23% Massive Reserve build up which has not been efficiently sterilised (266.5 billion USD)

In 2006-07 reserve money growth rose to 23%

Massive Reserve build up which has not been efficiently sterilised (266.5 billion USD)

Effects of RBI Intervention cont.. Rise in Inflation - From April 2006 to January 2007 RBI purchased USD 12.6 billion (Rs.56, 543.05 crores ).To reduce liquidity raised interest rates Tightening of credit - rise in repo rates , a rise in cash reserve ratio and a reduction in rate of interest on cash deposited by banks with RBI. Raise lending rates and reduce the amount of credit disbursed 05/28/09 Against RBI Interventions

Rise in Inflation - From April 2006 to January 2007 RBI purchased USD 12.6 billion (Rs.56, 543.05 crores ).To reduce liquidity raised interest rates

Tightening of credit - rise in repo rates , a rise in cash reserve ratio and a reduction in rate of interest on cash deposited by banks with RBI. Raise lending rates and reduce the amount of credit disbursed

Lesser growth in the economy - Reduced the level of investment activity in the economy, ( infrastructure sector) , small and medium entrepreneurs ,Housing Suddenness of the rupee movement

Lesser growth in the economy - Reduced the level of investment activity in the economy, ( infrastructure sector) , small and medium entrepreneurs ,Housing

Suddenness of the rupee movement

Inflationary pressure

Exports growth is reduced due to appreciating rupee Erroneous belief -Growth is not affected. Exports will become less competitive due to inflation if RBI buys dollars to keep the rupee from appreciating.This will reduce the growth in exports REER Real Effective exchange rate - Nominal exchange rate minus inflation. Higher inflation mops up the competitive advantage of a weaker rupee

Erroneous belief -Growth is not affected.

Exports will become less competitive due to inflation if RBI buys dollars to keep the rupee from appreciating.This will reduce the growth in exports

REER Real Effective exchange rate - Nominal exchange rate minus inflation. Higher inflation mops up the competitive advantage of a weaker rupee

Conclusion Support to Exporters – Provide Platforms like improving infrastructure, changing Labour Laws , hedging mechanisms . Transparency – Long Term policies Dincer & Eichengreen, 2007: On a scale of 0 to 15, RBI stagnated at 2 from 1998 to 2005. Asian average rose from 3 to 5.1. 05/28/09 Against RBI Interventions

Support to Exporters – Provide Platforms like improving infrastructure, changing Labour Laws , hedging mechanisms .

Transparency – Long Term policies Dincer & Eichengreen, 2007: On a scale of 0 to 15, RBI stagnated at 2 from 1998 to 2005. Asian average rose from 3 to 5.1.

Monetary policy announcements need to be made on preset dates When faced with the impossible trinity, all mature market economies of the world have chosen: floating exchange rate + autonomous monetary policy + open capital account.

Monetary policy announcements need to be made on preset dates

When faced with the impossible trinity, all mature market economies of the world have chosen: floating exchange rate + autonomous monetary policy + open capital account.

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