rbi-an assessment of recent macro economic developments

8/3/2019 RBI-An Assessment of Recent Macro Economic Developments

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Anassessmentofrecentmacroeconomicdevelopments(RevisedversionoftheKeynoteAddressbyDr.SubirGokarn,DeputyGovernor,totheOpeningPlenary

sessionofConfederationofIndianIndustrysCFOSummit2011onDecember3,2011inMumbai.Inputs

andfeedbackfromcolleaguesontheFinancialMarketsCommitteearegratefullyacknowledged.)

IntroductionThankyou for invitingme to sharemy thoughtsat theAnnualCIICFOSummit. In recentweeks, the

macroeconomicenvironmenthasbecomeparticularlyturbulent.Globalconditionshavecontributedto

asignificantrebalancingofportfoliosasaresultofrapidlychangingriskperceptionsandappetites.This

hasledto increased instabilityandvolatility infinancialmarkets,particularlycurrencymarkets.Onthe

domestic front, growth is deceleratingwhile inflation remains high,with upside pressures persisting

fromthesharpdepreciationintherupee.Whileoverallmacroeconomicconditionsmaycauseconcern,

weneedtotakean integratedandforwardlookingviewofpositiveandnegativeindicatorsandfuture

riskswhilethinkingaboutappropriatepolicyresponses.ThisiswhatIproposetododuringthecourseof

thistalk.

TheGlobalScenarioLetme first speakabout theglobal scenario.Over thepast twoyears, theperformanceof themajor

advancedeconomieshasraisedsignificantconcernsaboutthesustainabilityoftheglobalrecovery.By

contrast,emergingmarketeconomies(EMEs)havegenerallyshownreasonablegrowth,suggestingthat

theirdomesticdriversandincreasinglinkageswitheachotherhaveprovidedsomeoffsettotheslower

growth in advanced economies.However, periodically, either sovereign debt pressures in Europe or

growth volatility in the US, have heightened those concerns. The European debt problem has

unquestionablybeen

the

dominant

global

factor

over

the

past

few

months,

which,

in

turn,

has

been

a

sourceofvolatilityinassetandcurrencymarketsallovertheworld.Asprospectsofenduringsolutions

totheproblemhaveebbedandflowed,sohaveassetpricesandexchangerates.,Afterseveralweeksof

anticipation,mattersappeartobecomingtoahead. Theprospectsofasolutioncriticallyhingeonthe

EurosummitscheduledforDecember9th,wherearrangementsthatwillhelpstabilizeglobalmarketsare

expectedtobeannounced.

ImpactonIndiaandPolicyResponsesThe impactof thisrecentglobal instabilityon Indiahasbeenenormous. India isastructurallycurrent

accountdeficiteconomy.Thisdeficitis,inturn,financedbycapitalinflows,whichoverthepastseveral

years,had

been

large

and

stable

enough

to

more

than

offset

the

current

account

deficit.

For

afew

monthsduring the200809 financial crisis, thepositionwas reversedand,when thathappened, the

Rupeebehavedmuchlikeitdidoverthepastseveralweeks(Chart1).BetweenJuly2008andFebruary

2009, the Rupee depreciated by nearly 17 per cent. Essentially,when capital stops coming in, the

currentaccountdrivestheexchangerateand,naturally,thepressureistodepreciateinthefaceofthe

deficit. Withthekindofvolatilitywehaveseeninglobalcapitalflowsoverthisperiod,virtuallyallEME


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currencies faced pressure to depreciate. However, the eventual magnitude of change reflected

differencesbetweencountriesincurrentaccountconditionsaswellaspolicyresponses.

Forthepastfewyears,theexchangerateregime in Indiahasbeenwhatmightbebestdescribedasa

"boundedfloat".TherearevirtuallynorestrictionsonForeignDirectInvestment(FDI),exceptforlimits

onspecific

sectors,

and

portfolio

investment

in

equities.

However,

there

are

restrictions

on

debt

inflows,

drivenbyconsiderationsofexternalstability. These limitsrelatetoquantity,tenorandpricing.Short

termdebt istheleastpreferred,because it isseenasmostvulnerabletosuddenreversals,while long

termdebt,despiteriskconcerns, isseenascontributingtotheresource flow into infrastructure,so is

viewedmore favourably.Thesecontrolsondebtmightbeviewedas"structural"or"strategic"capital

controls;theyarealteredrelativelyinfrequentlyinresponsetochangingmacroeconomicconditionsand

notwithaviewtoimpactingthedailymovementoftheexchangerate.

Whilewedonot target the levelofexchange rate,nordowehavea fixedband fornominalor real

exchange rates to guide interventions, the capital account management framework helps in the

boundedfloat. If volatilityincreases,appropriatetools,includingthoseintherealmofcapitalaccount

management are used. Within these overall boundaries, the exchange rate is determined by daily

variationsindemandandsupply.Intherecentepisodeofdepreciation,asIindicatedearlier,asharpfall

incapital inflows ledtoadryingupofsupply,whiledemandonaccountofthecurrentaccountdeficit

continuedunabated,leadingtotheoutcomewesaw.

Therehasbeenalongstandingdebateonthemeritsanddemeritsofthisexchangeratepolicy,which

hasreturnedtocentrestageinthewakeofrecentdevelopments.Timedoesnotpermitmetogointoit

here,but it is important topointout that thedifferentpolicy responseswe sawacrossEMEs to the

volatilityincapitalinflowswerelargelytheoutcomeoftheirexchangeratepolicyframework.Countries

that orient their exchange rate regimes to export competitiveness typically have current account

surpluses.This

is

acharacteristic

of

the

Asian

EMEs

and,

in

this

sense,

India

is

asignificant

exception

to

theAsianrule.Thesesurplusesarereflected inabuildupofforeignexchangereserves,whichmaybe

further enhanced by large inflows of capital and the further accumulation of reserves to prevent

currency appreciation, which undermines competitiveness in the short run. In the current global

context, when capital inflows stop, reserves built up from current account surpluses provide the

capacitytomanageexchangeratesinthefaceofexternalpressure.

Indiahaslargereserves,ofcourse,over$300billion,butbecausewehaveacurrentaccountdeficit,the

reservesareessentiallycounterbalancedagainstourexternalliabilityposition.Inanextremescenario,if

there isa largeoutflowofcapital,theadequacyofreserveswillbejudgedbytheeconomy'sabilityto

financethe

current

account

deficit

and,

over

and

above

that,

meet

short

term

claims

without

any

disruptionorlossofconfidence.Inlightofthis,thevalueanduseofreservesintheIndiancontextmust

beviewedsomewhatdifferentlythaninthecontextofastructurallycurrentaccountsurpluseconomy.

Reservesessentiallyprovidecomforttoexternalcounterpartiesthatwehavethecapacitytomeetour

obligations.


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While the recent sharpdepreciationhas incertainquarters led toanassessmentof"helplessness" in

dealingwith thekindofglobal turbulenceweare seeing today,our strategicbehavior shouldnotbe

misconstrued as an inability to lean against thewind.Consider the following alternatives.Not using

reservestopreventcurrencydepreciationposestheriskthattheexchangeratewillspiraloutofcontrol,

reinforcedbyselffulfillingexpectations.Ontheotherhand,usingthemupinlargequantitiestoprevent

depreciationmay

result

in

adeterioration

of

confidence

in

the

economy's

ability

to

meet

even

its

short

termexternalobligations. Sincebothoutcomesareundesirable,theappropriatepolicyresponse isto

findabalancethatavoidseither.

ThatbalancecanbefoundinpreciselythestructuralcapitalcontrolsthatIreferredtoearlier.Resisting

currencydepreciation isbestdoneby increasing the supplyof foreigncurrencybyexpandingmarket

participation. This, in essence, has been our response. We increased the limit on investment in

government and corporatedebt instrumentsby foreign investors.We raised the ceilingson interest

ratespayableonnonresidentdeposits.Theallincostceiling forExternalCommercialBorrowingshas

beenenhanced.All these channelswillhelp toexpand the inflowof foreignexchange.These capital

controlmeasures

have

been

supported

by

aseries

of

administrative

measures,

which

are

aimed

at

curbingthecapacity (ortemptation)ofmarketparticipantstotakepositionsagainsttheRupee,which

may further aggravate the pressures to depreciate. For example, entities that borrow abroadwere

liberally allowed to retain those fundsoverseas,which in this environment,would fetch them some

windfallgains.Theyarenow required tobringtheproportionofthose funds tobeused fordomestic

expenditureintothecountryimmediately.

Insum,withinthebroadparametersofour"bounded float"approachtoexchangeratemanagement,

wedohavethe instrumentsandthecapacitytoenhancesuppliesofforeignexchange intothemarket

and,ashasbeendemonstratedbytheserecentactions,willusethemasappropriate.Withinthisoverall

framework,

let

me

address

the

issue

of

direct

intervention.

As

we

have

said,

our

policy

approach

does

not involve strong intervention in the currencymarket toachievea specific rate target. The risksof

doing this have already been pointed out. However, in excessively volatile market conditions,

"smoothing" interventionsthathelptokeepmarketsorderlyandprevent largejumpsthatcan induce

furtherspirals,areentirelyjustifiedandhavebeencarriedout.

Tosumupmythoughtsonthisissue,letmereemphasizethatourbroadobjective.Itistoensurethat

wefindabalancebetweentheshorttermriskoftheRupeespirallingdownwardsandthemediumterm

riskofalossofconfidenceinourabilitytomeetourexternalobligations.Wedohavetheinstrumentsto

do this in the formof strategic capital controls,which canbeused toenhance the supplyof foreign

exchange.Thesewillbeusedasappropriate,with thegoalofensuring that theavailabilityof foreign

exchangedoesnotbecomeadestabilizingconstraint.

However, wemust accept the likelihood of global turbulence persisting for some time, with the

consequent impacton assetprice and currency volatility. This is a risky environmentand everybody

wouldbewelladvisedtomitigatetheirriskstotheextentpossible.Overtime,thehedgingoptionsfor

variousstakeholders,includingbanks,corporatesandsmallexportershaveincreased.Accordinglythese


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stakeholders areadvised tobe vigilantandwellpreparedwithappropriate riskmitigation strategies,

evenwhilecentralbankactstosmoothexcessivevolatility.

But,beyondthis,ifwedoseetheshorttermriskofadownwardspiralescalating,wewillnothesitateto

useallavailable instruments.Notwithstandingourpreference forastrategicapproachtomanageour

externalexposures,

we

would

like

to

reiterate

that

to

safeguard

macroeconomic

stability,

use

of

interventiontomitigatetheimpactofsharpandlargemovementsintheexchangerate wouldremains

aninstrumentinourarmoury.

TheDomesticScenarioLiquidityLetmefirstaddresstheimmediateconcernaboutRupeeliquidity,which,insomeways,isrelatedtothe

external situation. For several weeks now, the tightness of domestic liquidity conditions has been

highlighted by the fact that borrowing under the Liquidity Adjustment Facility (LAF) have been

significantlyabove

our

comfort

threshold

of

one

per

cent

of

Net

Demand

and

Time

Liabilities

(NDTL).

Recent developments in our liquidity management approach have involved making a distinction

betweenthemonetarystanceandthe liquiditystance(Chart2). InDecember2010,we exploitedthis

distinctionbycarryingoutOpenMarketOperations(OMOs)to inject liquidity intothesystem,despite

maintaininganantiinflationarymonetarystance.

We appear to be in a somewhat similar situation now. Some of the tightness is attributable to the

smoothinginterventionsthatwerecarriedoutintheforeignexchangemarket.But,thatapart,giventhe

overallconditionsandtheadditionalpressure,eveniftransitory,thatwillbeexertedbytheadvancetax

payments inmidDecember,domestic liquidity conditionsareexpected to remainstretched forsome

time.

Here again, the broad objective is to ensure that these conditions do not hamper the smooth

functioningoffinancialmarketsanddisruptflowstotherealeconomy.Wehavebeeninjectingliquidity

intothemarketthroughLAFandOMOsandwillcontinuetodosoasconditionswarrant.Ofcourse,we

must guard against the risk of excessive accommodation, since this will conflict with our current

monetarypolicy stance.But,havingmadeadistinctionbetween the two,wewill tryandensure that

liquidityremainsadequatewithoutthreateningtheinflationarysituation.Inshort,theendeavourwillbe

tokeepitwithintheparametersconsistentwithourcomfortlevelsforaliquiditydeficit.

Wedohavearangeofinstrumentstohelpusachievethisobjective.Currently,thebankingsystemasa

wholeholds

government

securities

to

the

tune

of

29

per

cent

of

NDTL,

which

is

five

per

cent

above

the

statutoryrequirementof24percent.Thisreflectsarelativelylargecapacityforliquidityinfusions,about

`2,74,000crores, asandwhentheneedarises.ItiscalledtheStatutoryLiquidityRatio(SLR)foragood

reason. OMOsareourfirstpreferenceforliquidityinjection,sincetheyaretacticalinnatureanddonot

requireachange inanypolicystance,realorperceived.Further,although ,OMOsarecurrentlybeing

used tomake those infusions, theLAFwindow isalwaysavailable to the system to theextentof this


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surpluscapacity. Inaddition,therecentlyestablishedMarginalStandingFacility(MSF)allowsbanksto

useafurtheronepercentoftheirSLRholdings,which,giventhe interestratestructure,theywillonly

do insituationsofextremestress. Inrecentweeks,therehasbeennorecoursetothiswindow,which

couldmeanthatthethereisn'ttoomuchstressinthesystem.Inasense,thiswindowservesasanearly

warningindicatorandwewatchitveryclosely.

Beyond this setof instruments, there areothers, like the SLR itselfand,ultimately, theCRR.But, in

thinkingabouttheseinstruments,wemustkeepinmindthattheystraddlethedividebetweenliquidity

and monetary management, which, at the current juncture, we are intent on maintaining. To

summarizethebroadobjectiveonthisfront,itistoensurethatdomesticliquidityconditionsdonotde

stabilizefinancialmarketsorflowstotherealsector,withintheoverallconfinesofthecurrentmonetary

policystance. Importantly,we mustrealizethat large fiscaldeficitscannotbeaccommodatedfullyby

OMOs.Fiscalconsolidation isahighpriority. Inadequateprogressonthis frontwillweaken monetary

controlandimpactmediumterminflationexpectations.

GrowthandInflationDynamicsFinally, letme say a fewwordsondomestic growthand inflationdynamics,which takeus from the

immediatetosomewhatfurtherintothefuture.Here,Iamtreading onfamiliarground,sinceitisjust

aboutamonthsinceourlastquarterlypolicyreview.Ofcourse,some thingshavechangedsincethen,

mostnotably, theextentofdepreciationof theRupeesince thatannouncement. Inandof itself, this

clearlyheightensinflationrisks.Theserisksareperhapsaggravatedbythefactthat,amidstalltheglobal

turbulence,crudeoilpriceshaveremainedquitefirm.Whiletherelativestabilityofoilprices indollar

terms would have provided a strong favourable base effect for domestic inflation beginning in

December, thiswillbeoffset somewhatby thedepreciationof theRupee.However,ourprojections

suggestthattheimpactwillnotchangetheanticipateddownwardtrajectoryofinflation.Ifasustainable

solutionto

the

European

sovereign

debt

problem

emerges

over

the

next

few

weeks,

global

portfolio

rebalancingcould reverse themovement in theRupee,which in turnwillhelpmoderate the inflation

risk. Importantly,apartfromoil,pricesofsomeothercommoditieshaveshownsomesignsofsoftening,

whichisobviouslypositivefortheinflationoutlook.

On the growth front, the recently published estimates for Q2 of 201112 substantiate the general

expectationofa moderation in growthduring the current year. Someof this isattributable to the

cumulative impactof interest ratehikes. In this sense, it isanexpectedoutcomeofmonetarypolicy

actions,which, as iswellknown,work to curb inflation bymoderating demand. Typically, a growth

decelerationprecedesan inflationdeceleration,so thepatternplayingoutnow isconsistentwith the

expectationthat

inflation

will

begin

to

moderate

over

the

next

few

months.

This

has

been

the

basis

of

ourprojectionsandguidanceon futurepolicyactions.Of course, therehavebeenother factors that

have impacted aggregate demand, especially the investment component.However,just aswith the

exchangerateandinflation,therearegrowthrisksaswell.Persistentglobalturbulenceisalwaysgoing

toadversely impactthe investmentclimate,whichmaybe furtheraggravatedbydomesticconditions.

Apart from interest rates, investment activity, which is critical to sustaining high growth with low


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inflation,isalsosensitivetoanumberofotherfactors.Policyactions,bothonthefiscalandregulatory

fronts, that can favourably impact the investment climate will be critical tomitigating the risks to

growth.These run thegamut from tax reform to landacquisition to skilldevelopment.Anumberof

initiativesoneachofthesefrontsarevisible,butquickresolutionandimplementationisthekey.

Animportant

risk

factor

that

we

have

been

consistently

highlighting

is

food.

Although

data

from

the

most recentweekspoints toa steadydecline in food inflation , the likelihood is that foodpriceswill

remain a persistent source of inflationary pressure unless there are significant improvements in

productivity, both at the cultivation stage and in the distribution process.Many forces need to be

brought intoplayquicklytoachievethis infrastructure,technologyandextensionservices,reformof

marketinstitutionsandrealignmentofpriceincentivesandfinancialservicesthatcansupportthem.

However,tocomebacktothegrowthandinflationviewoverthenextyear,inascenarioinwhichglobal

turbulence reduces, we should see inflationmoderating, which would then help the growth cycle

reverse. Even in this scenario, reforms that improve the investment climate are critical. If global

uncertaintypersists, makingus evenmoredependentondomesticdrivers to sustain growth, these

reforms becomeabsolutelyessential

ConcludingRemarks

LetmeconcludebysummarizingthemainpointsthatIwantedtomakeinthisaddress.First,indealing

withglobal turbulenceand its shortterm impacton India,weneed tobalancebetween the riskofa

rupeespiralandthatofalossofconfidence.Ourcapitalaccountmanagementframeworkgivesusthe

capacitytodothisandwewillcontinuetousethatcapacityasappropriate.Wehavetorecognizethat

volatilitymaybewithusforawhileandwehavetodealwithit.However,iftheriskofaspiralescalates,

reflectedin sharpmovementsintheexchangerate,wewill takeswiftactionasandwhennecessary.

Second,domesticliquiditymaybeshowingsignsofstress.Hereagain,wehavetheinstrumentsandthe

willingnesstousethem,inthecontextofourdistinctionbetweenliquiditymanagementandmonetary

policy.

Third,while therearemanychallengestomanaging thegrowthinflationdynamics,bothexternaland

domestic,they aremanageable.Moderatinggrowthwillhelpeaseinflationarypressures,whichinturn

will help growth stabilize. Of course, accelerating growth over the longer term without provoking

inflation requiresmany structural changes, onwhich the policy establishmentmust put the highest

priority.

Letme

end

by

thanking

the

organizers

once

again

for

inviting

me

to

speak

at

this

event

and

for

accommodatingmy scheduling constraints through the use of this video recording. I trust thatmy

remarkshaveservedasausefulinputtoyourdiscussions.Mybestwishesforaproductiveday.


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Chart1:ExchangerateofIndianRupee

50

57

64

71

78

85

41

43

45

47

49

51

53

55

30-Aug-09

26-Sep-09

23-Oct-09

19-Nov-09

16-Dec-09

12-Jan-10

8-Feb-10

7-Mar-10

3-Apr-10

30-Apr-10

27-May-10

23-Jun-10

20-Jul-10

16-Aug-10

12-Sep-10

9-Oct-10

5-Nov-10

2-Dec-10

29-Dec-10

25-Jan-11

21-Feb-11

20-Mar-11

16-Apr-11

13-May-11

9-Jun-11

6-Jul-11

2-Aug-11

29-Aug-11

25-Sep-11

22-Oct-11

18-Nov-11

Rs/US$ Rs/GBP (Rt. Scale) Rs/Euro (Rt. Scale)

Chart2:ExchangerateofIndianRupee

100000

50000

0

50000

100000

150000

200000

1Aug11

8Aug11

15Aug11

22Aug11

29Aug11

5Sep11

12Sep11

19Sep11

26Sep11

3Oct11

10Oct11

17Oct11

24Oct11

31Oct11

7Nov11

14Nov11

21Nov11

28Nov11

5Dec11

12Dec11

19Dec11

26Dec11

LAFinjectionandRBIcomfortzone

LAF injection Positive1percentNDTL Negative1per centNDTL

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rbi-an assessment of recent macro economic developments

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