Rupee Impact on
Indian Architecture
A Seminar by NIRC –ICAI
on 10.08.2013.
Presentation by
Mrs.M.Vedavalli
Rupees Stability and Monetary Policy
 The Preamble of the Reserve Bank
of India Act describes the basic
functions of the Reserve Bank as:
 "...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."
 Financial stability has also
become an objective since 2000
 Monetary Policy was the first
line of defence in a currency
crisis.
The Monetary Policy
IMPLEMENTATION/
TACTICS
Instruments
1. Official interest
rates
2. Reserve
requirements
3. Market
operations
4. Direct controls.
Operating
objectives/
targets
1. Short term money
market rates
2. Bank reserves
STRATEGY
Intermediate targets
Indicators of goal variables
Indicators of policy stance
1. Exchange Rates
2. Longer-term interest rates
3. Money/credit
4. Asset prices
5. Long-term growth
Final
Goals
1. Price stability
2. Long-term
growth
3. Financial
Stability
Monetary Policy in Globalised World
 Impossible Trinity
Trilemma
 Simultaneous
Maintenance of 3 Policy
Goals not possible
 Free Capital Flows
 Fixed Exchange Rate
 Independent Monetary
Policy
Monetary Policy in Globalised World
 If Open Economy with Independent Monetary Policy
 Then Drop Fixed Exchange Rate
 If Exchange Rate is pegged
 then forego independent monetary policy
 India’s Position
 Middle Path - giving up on some flexibility on each of
the variables to maximize overall macroeconomic
advantage.
India’s Middle Path
 (i) Exchange rate largely market determined, but
intervention in the market to smooth excess volatility
and/or to prevent disruptions to macroeconomic
stability;
 (ii) Capital account is only partly open; NO FCAC
 (iii) Because of the liberalization on the exchange rate
and capital account fronts, some monetary policy
independence is forfeited.
 Always vigilant on all the three fronts with emphasis
shifting across the three pillars depending upon the
macroeconomic environment.
Forex Reserves
 In India, foreign exchange
reserves are defined as
external assets which are
readily available to &
controlled by RBI for
meeting BoP financing
needs, for intervention in
exchange
markets
to
contain the volatility of
exchange rate of the rupee
and for other related
purposes.
Forex Reserves contd….
 At present, reserves include
foreign currency assets of the RBI,
gold, SDRs & Reserve Tranche
Position in the IMF which
conforms to international best
practices as suggested in the IMF
manual.
 Since 1993, the RBI has intervened
in the forex market to keep an
orderly movement in the value of
the rupee. This approach kept the
economy on track, but now the
volatility in rupee movement
threatens its derailment.
During 2012-13, there was a decline in the foreign exchange reserves. The sources of
variation in the foreign exchange reserves are set out in Table below.
Table 1: Sources of Variation in Foreign Exchange Reserves*
Items
(US $ billion)
AprilAprilMarch
March
2011-12
2012-13
-78.2
-88.2
65.4
92.0
39.2
46.7
22.1
19.8
17.2
26.9
Current Account Balance
Capital Account (net) (a to f)
a. Foreign Investment (i+ii)
(i) Foreign Direct Investment
(ii) Portfolio Investment
Of which:
FIIs
16.8
27.6
ADRs/GDRs
0.6
0.2
b. External Commercial Borrowings
10.3
8.5
c. Banking Capital
16.2
16.6
of which: NRI Deposits
11.9
14.8
d. Short-Term Trade Credit
6.7
21.7
e. External Assistance
2.3
1.0
f. Other Items in Capital Account
-9.4
-2.4
Valuation Change
2.4
-6.2
III.
Total (I+II+III) @
-10.4
-2.4
*: Based on old format of BoP
@: Difference, if any, is due to rounding off.
Note: (i) ‘Other items in capital account’ apart from ‘Errors and Omissions’ include SDR
allocations, leads and lags in exports, funds held abroad, advances received pending issue of
shares under FDI and transactions of capital receipts not included elsewhere.
(ii) Increase in reserves (+) / Decrease in reserves (-).
I.
II.
Table 2: Comparative Position of Variation in Reserves
Items
1. Change in Foreign Exchange Reserves (Including Valuation Effects)
2. Valuation Effects (Gain (+)/Loss (-))
3. Change in Foreign Exchange Reserves on BoP basis (i.e., Excluding Valuation
Effects)
4. Percentage of increase/decline in Reserves explained by Valuation Gain/Loss
Note: Increase in reserves (+)/Decrease in reserves (-).
Difference, if any, is due to rounding off.
(US$ billion)
AprilAprilMarch
March
2011-12 2012-13
-10.4
-2.4
2.4
-6.2
-12.8
3.8
-23.1
262.7
On a balance of payments basis (i.e., excluding valuation effects), the foreign exchange reserves
increased by US$ 3.8 billion during 2012-13 as against a decline of US$ 12.8 billion during 201112. The foreign exchange reserves in nominal terms (including the valuation effects) declined by
US$ 2.4 billion during 2012-13 as compared to a decline of US$ 10.4 billion during the previous
year .
Introduction : Journey of E.C.
EC was introduced on 03.09.1939 as a temporary
measure under Defence of India Rules, 1939.
Placed on statutory basis by enacting F.E.R. Act,
1947 w.e.f. 25.03.1947.
F.E.R. Act, 1947 was replaced by F.E.R. Act, 1973
w.e.f. 01.01.1974.
BoP crisis were experienced in 1990.
Reforms process started in 1991 onwards.
Phases of EC


EC has been in
existence since 2009
These 7 decades
can be divided into
distinct three
phases.
1939-1990
Control regime
1991-2000
Reforms regime
2000 onwards
FEMA regime
Structural Reforms initiated
 Announcement of New Industrial Policy 1990.
 Adoption of floating exchange rates based on market forces, i.e.







demand and supply (LERMS / U-LERMS).
Liberalisation and simplification of the procedure /
documentation.
Delegation of powers to Authorised Dealers.
Amendment to F.E.R. Act, 1973 in 1993.
Adoption of article VIII of IMF accepting full convertibility of
current account w.e.f. 20.08.1994.
Constitution of Committee on Capital Account Convertibility in
1997.
Replacement of FERA, 1973 by FEMA, 1999
FCAC 2006
Salient features of FEMA
1.
• Shift in Objective (facilitating external trade and payments
and for promoting the orderly development and
maintenance of foreign exchange market in India ).
• Fx transactions catagorised – Current / Capital.
2.
3.
• Government (current a/c.)/ RBI (capital a/c.) powers clearly
demarcated.
Forex Transactions
 Capital
account transaction”
means a transaction which alters
the assets or liabilities, including
contingent liabilities, outside
India of persons resident in
India or assets or liabilities in
India of persons resident outside
India
 Underlying principle – current
account transactions which are
not restricted are permitted
(negative list); whereas capital
account regulations indicate the
transactions
which
are
permitted (positive list)
Current account transactions
 Govt. by rules notified under Sec.5 of FEMA, 1999.
 Categorized in three schedules –
 Sch. I- prohibited items (8)
 Sch. II- subject to Govt. approval (10)
 Sch. III- subject to RBI approval (13)
 All current a/c. transactions are undertaken by APs
under delegated powers.
Capital account transactions
 Governed
by
regulations
notified by RBI in consultation
with GoI.
 Separate
regulations
for
investments,
borrowings,
lending, deposits, export and
import of currency, guarantees,
surrender of foreign exchange,
foreign
currency
accounts,
remittance of assets, immovable
property, derivative contracts,
etc
 Most of the transactions could
be undertaken under the general
permission
Need for Rules and Regulations
 India is not fully convertible on




Capital account.
The indicative limits on few
current account transactions are
designed for restricting capital
transfers
through
current
account.
Regulating the forex market.
Realisation & repatriation of
export proceeds and surrender
of forex earnings are mandatory.
One of the counter party to any
forex transactions should be an
AP, licensed by RBI.
Capital account convertibility- Approach
 It is a process not an event.
 Gradual implementation.
 Guided by FCAC Report and consistent with macro-
economic and global developments and ability to meet
concomitants.
 Cautious implementation to avoid back-tracking.
 Extremely cautious about two areas• Unlimited access to short term external commercial borrowings for
meeting working capital and other domestic requirements.
• Providing unrestricted freedom to domestic residents to convert
their domestic bank deposits and idle assets such as real estate in
response to market developments or exchange rate expectations.
Lessons from Country Experiences
 Even under fully convertible
environment, prudential
safeguards are necessary to
insulate the economies from
potential capital account crises
 Gradual approach to
liberalization is being used as a
tool for furtherance of sound
macro-economic and prudential
policies
 Exchange rate flexibility is
important while undertaking
capital account convertibility
Lessons from Country Experiences


Liberalization can be
beneficial when countries
move in tandem with strong
macroeconomic policies,
sound financial systems and
markets, supplemented by
prudential regulations and
robust supervisory
framework, accounting and
disclosure standards
Emerging markets which
failed to mitigate the flows
through sterilization had to
re-impose capital controls
(recent examples of Thailand,
Colombia, Brazil, etc) or
backtracked
Active capital account management
 A variety of measures to manage the flows for
reducing overheating, currency appreciation and
vulnerability to sharp reversal of flows
 Monetary policy measures
 Prudential measures
 Capital control measures and liberalization of
outflows
Issues and challenges
 The risks of CAC, trigger from
inadequate preparedness in
terms of prudential regulation
and supervision, development
of markets, instruments for
risk transfer, copious capital
flows, sudden reversal of flows
 Actual implementation should
be dictated by macroeconomic
conditions, unusual events
 Large capital flows and sudden
reversals have warranted a
revisit to the policy of
liberalization
 Asymmetry in policy related
issues- fiscal, markets, etc
How Capital Flows?
 Capital flows – not steady but
volatile.
 Respond to both push and
pull factors.
 Push factors the monetary
stance of advanced economy
central banks - determines
the liquidity in the global
system
 the need of global investors
for asset diversification. Pull
factors : Promise of growth in
Emerging Economies, their
stable and credible policy
environments and improved
governance.
Adequacy of Reserves
 To gauge the ability to absorb external shocks
 Traditional approach - in terms of import cover
 Size, composition and risk profiles of various types of
capital flows
 Types of external shocks to which the economy is
vulnerable
Adequacy of Reserves
 Usable foreign exchange reserves >scheduled
amortisation of foreign currency debts (assuming no
rollovers) during the following year
 "Liquidity at Risk" rule that takes into account the
foreseeable risks that a country could face.
Global Financial Crisis
• Sub- Prime Crisis in USA. Collapse
of the leading US investment
banks in August-September 2008.
• Problem of contagion – across
markets, across institutions and
across countries.
• Risk aversion, deleveraging and
frozen money markets – Increase
in the cost of funds
• Lesson: Irrespective of the degree
of globalisation of a country and
the soundness of its domestic
policies, a financial crisis could
spread
to
every
economy.
De Coupling Theory proved
wrong
Impact of Financial Crisis in Indian Real
Sector
 Moderation in growth in the
second half of 2008-09 in
comparison with the robust
growth performance in the
preceding five years (8.8 %
p.a)
 Negative growth in industrial
output in Q4 of 2008-09 – a
decline for the first time since
the mid-1990s.
 Erosion of external demand
affected industrial
performance
Crisis Impinging on Monetary Policy
 Unprecedented international transmission of
liquidity shocks
 Falling asset prices -uncertainty about valuation of
the traded instruments affected market liquidity
 Failure of leading global financial institutions and
the deleveraging process tightened the market for
funding liquidity.
 Growing risk of illiquidity cascading into solvency
problems- credit and quantitative easing acquired
priority in most central banks.
Action Taken
 The contagion
1.
2.
3.

warranted swift
monetary
and
fiscal
policy
responses to ensure
orderly functioning of markets,
preserving financial stability,
Moderating its adverse effects on
growth.
Measures
taken for improving
domestic and foreign currency
liquidity through rate cuts, CRR
cut, additional liquidity support,
Easing of ECB norms, relaxing
interest rate ceiling on forex
deposits, borrowing norms for
banks, loans to mutual funds,
introduction of currency futures,
FCEBs etc.
Aftermath of Crisis
 Quantitative easing policies of advanced economy
central banks.
 Global system awash with liquidity.
 Capital flown into EMEs, posing the familiar problem
of capital surges.
 The tail risks to global recovery had eased in the early
part of the year.
Impact
 Changes in the Reserve Bank’s policy rates were
quickly transmitted to the money and debt
markets.
 Transmission to the credit market was slow due to
several structural rigidities in the system,
especially the dominance of fixed term deposit
liabilities in banks’ balance sheets at fixed interest
rates.
Growth V/s Inflation Dynamics
 Monetary policy stance over the
last two years has predominantly
been shaped by the growthinflation dynamics, even as
external sector concerns have had
a growing influence on policy
calibration over the last one year.
 The current situation –
moderating wholesale price
inflation, prospects of softening
of food inflation consequent on a
robust monsoon, and
decelerating growth – would have
provided a reasonable case for
continuing on the easing stance.
Bernanke’s Announcement Effect
 Flash turmoil in the financial
markets in late May because of
the ‘announcement effect’ of
the tapering of quantitative
easing (QE) by the US Fed
 Market expectations of QE
taper and the consequent
increase in real interest rates in
the US have translated into a
rapid appreciation of the US
dollar
and
consequent
depreciation
of
EDE
currencies.
 Commodity prices generally
softened, but the price of crude
remains elevated.
Indian Scene
 Risks to growth increased notwithstanding the robust onset and




spread of the monsoon.
Industrial production slumped, with lead indications of
declining order books and input price pressures building on
rupee depreciation. services sector activity is also subdued in
part because of adverse spillovers from tepid recovery around the
world.
Export performance undermined, even as heightened volatility
in capital flows has raised external funding risks.
Outflows of portfolio investment particularly from the debt
segment. Ensuing exchange market volatility.
Wholesale price inflation pressures are on the ebb, but retail
inflation remains high.
CAD worrying Factor
 Rupee dollar rate touched a record low of Rs.61.5355 on
August 6, 2013 as compared to Rs.54.2415 as on May 9, 2013.
 The CAD moderated to 3.6 per cent of GDP in Q4 of 201213, down from 6.5 per cent in Q3, due to narrowing of the
trade deficit. However, for 2012-13 as a whole, the CAD was
4.8 per cent of GDP, well above the sustainable level of 2.5
per cent of GDP.
 In the current year, the trade deficit widened during Q1
over its level a year ago, mainly on account of deteriorating
export performance. Financing came by way of higher FDI,
net ECBs and accretion to non-resident deposits, with
some use of reserves.
Measures Initiated by RBI & GOI
 June 4 : To curb import demand, import of gold on
consignment basis was restricted on June 4
 June 5: customs duty was raised
 July 8 : Banks restricted to trade only on behalf of
their clients in currency futures/options markets,
exposure norms tightened, Margins on currency
derivatives raised to check speculative activities.
 July 15: MSF rate raised by 200 bps to 10.25 per cent,
overall access by way of repos under the LAF restricted
to Rs.750 billion.
RBI Measures
 July 18, 2013: Dedicated Special Repo window for a
notified amount of Rs. 250 billion for liquidity support
to mutual funds to tide over redemption problem.
 July 22, 2013: All nominated banks/entities to ensure
that at least one fifth of imported gold is exclusively
made available for the purpose of exports. Any import
of gold under any type of scheme will have to follow
this 20/80 formula. Consequent to this, the earlier
instructions banning the import of gold on
consignment basis were withdrawn.
RBI Measures
 July 23, 2013 : Access to LAF by way of repos at each
individual bank level restricted to 0.5 per cent of the
bank’s own NDTL effective July 24, 2013.
 The cash reserve ratio (CRR), which banks have to
maintain on a fortnightly average basis subject to a
daily minimum requirement of 70 per cent, was
modified to require banks to maintain a daily
minimum of 99 per cent of the requirement.
 August 8, 2013: RBI will auction Government of India
Cash Management Bills for a notified amount of Rs.
22,000 crore once every week on Mondays.
Impact on Economy
Impact on Economy
 Growth projection for 2013-14 is revised downwards from 5.7 per




cent to 5.5 per cent.
Sharp depreciation of the rupee since mid-May is expected to pass
through in the months ahead to domestic fuel inflation as well as to
non-food manufactured products inflation through its import
content. Price of Imported coal goes up leading to power tariff
increase which in turn will impact the common man. Supply
constraints in food and infrastructure fuelling inflation.
It comes down to the common man, it leads to inflationary trends,
and therefore it also affects the interest rates.
CAD > sustainable level for 3 years in row. External vulnerability
indicators have deteriorated. Economy’s resilience to external
shocks is eroded and structural reforms required.
Increase in resources raised by commercial sector from domestic
banks and from abroad, especially through external commercial
borrowings (ECBs) and foreign direct investment (FDI).
Reserve Bank’s Stance
The four broad contours of monetary policy stance are:
1. to address the risks to macroeconomic stability from
external shocks;
2. to continue to address the heightened risks to
growth;
3. to guard against re-emergence of inflation
pressures; and
4. to manage liquidity conditions to ensure adequate
credit flow to the productive sectors of the economy.
RBI’s Guidance
 The recent liquidity
tightening measures by
the Reserve Bank are
aimed at checking undue
volatility in the foreign
exchange market and
will be rolled back in a
calibrated manner as
stability is restored to
the foreign exchange
market.
THANK
YOU!!!!