A Seminar by NIRC

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A Seminar by NIRC ICAI on 10.08.2013.Presenta
tion by Mrs.M.Vedavalli
Rupee Impact on Indian Architecture
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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.

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The Monetary Policy
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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

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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
• Indias Position
• Middle Path - giving up on some flexibility on
  each of the variables to maximize overall
  macroeconomic advantage.

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Indias 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.

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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.

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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.

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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.
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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
2011-12. 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 .
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Introduction Journey of E.C.
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Phases of EC

• EC has been in existence since 2009
• These 7 decades can be divided into distinct
  three phases.

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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

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Salient features of FEMA
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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)

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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.

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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

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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.

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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.

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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

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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

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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

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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

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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.

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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

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Adequacy of Reserves

• Usable foreign exchange reserves gtscheduled
  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.

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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

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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

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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.

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Action Taken

• The contagion 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.

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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.

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Impact

• Changes in the Reserve Banks 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.

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Growth V/s Inflation Dynamics

• Monetary policy stance over the last two years
  has predominantly been shaped by the
  growth-inflation 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.

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Bernankes 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.

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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.

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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
  2012-13, 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.

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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.

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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.

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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 banks 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.

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Impact on Economy
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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 gt sustainable level for 3 years in row.
  External vulnerability indicators have
  deteriorated. Economys 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).

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Reserve Banks Stance

• The four broad contours of monetary policy stance
  are
• to address the risks to macroeconomic stability
  from external shocks
• to continue to address the heightened risks to
  growth
• to guard against re-emergence of inflation
  pressures and
• to manage liquidity conditions to ensure
  adequate credit flow to the productive sectors of
  the economy.

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RBIs 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.

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THANK YOU!!!!