Rbi and impossible_trinity


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Rbi and impossible_trinity

  2. 2. FLOW OF PRESENTATION<br />Introduction<br />Impossible Trinity<br /><ul><li>Capital Mobility
  3. 3. Exchange Rate
  4. 4. Monetary Policy or Fiscal Policy</li></ul>Why should RBI deal with Impossible Trinity<br />Managing Capital Mobility<br /><ul><li>Reasons for rising capital inflows
  5. 5. Managing Capital flows</li></ul>Managing Foreign Exchange Rate<br />Managing Monetary Policy<br />Conclusion<br />
  6. 6. INTRODUCTION<br />Pre 1990<br />Fiscal dominance and associated Financial Repression<br />Post 1990<br /><ul><li>Regulated Economy Growing Degree of deregulation and Liberalization
  7. 7. Fiscal dominance monetary-fiscal coordination
  8. 8. Exchange rate has been largely market-determined since March 1993.
  9. 9. The capital account has been liberalised in terms of inflows as well as outflows.
  10. 10. Monetary policy signals are now largely transmitted through changes in policy rates.</li></li></ul><li>IMPOSSIBLE TRINITY<br />The Impossible Trinity is the hypothesis in macroeconomics that it is impossible to have all three of the following at the same time:<br /><ul><li>Exchange rate stability
  11. 11. Free capital movement
  12. 12. An independent monetary policy.</li></ul>Also known as the Inconsistent Trinity, Triangle of Impossibility or Unholy Trinity<br />
  13. 13. IMPOSSIBLE TRINITY<br />
  14. 14. CAPITAL MOBILITY-FULL OR LIMITED<br /><ul><li>Capital Inflows</li></ul>Direct Benefit<br /> Generally domestic savings not enough for development of economies Need Foreign capital<br />Indirect Benefits<br /><ul><li>Development of domestic financial sector
  15. 15. Improved macroeconomic policies
  16. 16. Capital Outflows</li></ul>Benefits<br /><ul><li>People and Companies can diversify their portfolios and take advantage of growth opportunities elsewhere</li></ul>Flipside: Can lead to financial crisis<br />
  17. 17. EXCHANGE RATE - FIXED OR FLOATING<br />Fixed Exchange Rate Systems: Prone to crisis<br />Floating Exchange Rate Systems: Exchange rate fluctuation driven by international speculative flows volatile <br />Many countries opt for “managed floating system”<br />
  18. 18. MONETARY POLICY OR FISCAL POLICY<br /><ul><li>Fiscal Policy</li></ul>Direct role: To increase output getting limited <br />Indirect role: To enhance competition and private sector participation increasingly appreciated <br /><ul><li>Monetary policy</li></ul>Role: Maintaining low inflation important for sustained growth<br />
  19. 19. Price Stability<br />Exchange Rate Stability<br />Exchange Rate Stability<br />Price Stability<br />
  20. 20. WHY SHOULD RBI DEAL WITH THE IMPOSSIBLE TRINITY?<br />The Preamble of Reserve bank of India Act 1934, <br />"...to regulate the issue of Bank Notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage.“<br />Three years of growth over 9%, India's economy expanded 6.7% in 2008/09 fiscal year<br />This year projections start at 7.2%, some even believe that India can overtake China as the fastest growing nation in the world.<br />
  21. 21. WHY SHOULD RBI DEAL WITH THE IMPOSSIBLE TRINITY?<br />Significant fiscal stimulus and loose monetary policy<br />Inflation<br />Weaker monsoon has pushed cost of food significantly higher<br />The magnitude of capital flows has become quite large and if not managed properly, would lead to instability in the economy.<br />
  22. 22. MANAGING CAPITAL MOBILITY<br />BENEFITS<br /><ul><li>Financing Investment
  23. 23. Economic growth</li></ul>PROBLEMS<br /><ul><li>Push up money aggregates
  24. 24. Inflationary pressures
  25. 25. Destabilize exchange rate
  26. 26. Affect domestic financial sector </li></li></ul><li>RISING CAPITAL INFLOW<br />Indian economy was growing at 8.5% plus from 2004 to 2008.<br />Interest rate cut by the central Banks in developed economies.<br />Need to build infrastructure capacities in the country.<br />
  27. 27. MANAGING CAPITAL FLOWS<br />Restricting capital flows – credibility<br />The best way to absorb huge capital inflows is to strengthen the financial system.<br />The RBI has actively withdrawn liquidity from the system.<br />Some restrictions on capital inflows have recently been introduced, primarily on corporate borrowing. <br />
  28. 28. MANAGING FOREIGN EXCHANGE RATE<br />Predominant objective - Flexible exchange rate<br />The exchange rate policy is guided by the need to <br /><ul><li>reduce excess volatility
  29. 29. prevent the emergence of destabilising speculative activities
  30. 30. help maintain an adequate level of reserves
  31. 31. develop an orderly foreign exchange market</li></li></ul><li>MANAGING MONETARY POLICY<br />Domestic demand remains the key driver of economic activity<br />Monetary and credit aggregates was broadly in line with demands of the real economy<br />Monetary policy was conducted with a view to ensuring not only price stability but also financial stability.<br />
  32. 32.
  33. 33.
  34. 34. CONCLUSION<br />Key elements of RBI’s policy have been<br /><ul><li>Active management of the capital account, especially debt flows
  35. 35. Flexibility in exchange rate movements but with capacity to intervene in times of excessive volatility;
  36. 36. Treating capital flows as largely volatile unless proven otherwise
  37. 37. Building up of adequate reserves
  38. 38. Sterilisation of interventions in the foreign exchange market through multiple instruments, including cash reserve requirements</li></ul>Monetary policy needs to move away from narrow price stability/inflation targeting objective.<br />
  39. 39. REFERENCES<br />“Exchange Rate Policy and Modelling in India” by PamiDua and Rajiv Ranjan<br />Working PaperNo. 401- “Managing the Impossible Trinity:Volatile Capital Flows and Indian Monetary Policy”By Rakesh Mohan and MuneeshKapur<br />Reddy, Y.V., 2008, “Management of the Capital Account in India: Some Perspectives”, Reserve Bank of India Bulletin, February.<br />“RBI and Impossible trinity” AmolAgrawal<br />http://www.imf.org/external/pubs/ft/survey/so/2008/CAR02408A.htm<br />http://www.tradingeconomics.com/Economics/GDP-Growth.aspx?Symbol=INR<br />http://www.investopedia.com<br />