The Hindu Business Line : Will rupee rise stem inflation?

With the dollar flood threatening to become a deluge, from the single-minded focus on tinkering repo rates and the CRR, the RBI, in its annual monetary policy statement, has turned its attention to measures that could arrest capital inflows, which complicate both exchange rate and liquidity management.

The unwanted dollars have driven up the rupee, forcing the central bank of one of the (still) poorest countries in the world to defend the currency of the world's richest country!

The RBI's measures are significant steps to encourage both corporate and individual citizens to look outward - westward ho! might be an apt description. Consider the following: overseas investment limit of corporates enhanced to 300 per cent of net worth from 200 per cent, mutual funds allowed to invest up to $4 billion abroad ($3 billion now), ceiling on prepayments of foreign borrowing increased to $ 400 million from $ 300 million and `no questions asked remittances/investments' of individuals raised to $100,000 from $50,000.

Besides, interest rates on FCNR deposits have been reduced below LIBOR and those on NRI rupee deposits equated to LIBOR - effectively near-zero rates given forward premiums.

Will these steps staunch the dollar inflows? Unlikely, with India being on the radar screen of investors and fund managers in (one is told) distant and remote Finland and Iceland. Also, we are being swamped by the new found love of NRIs for their country. Tens of billions of dollars are being repatriated home by Indians or those of Indian origin living abroad.

A little reflection suggests that this is one gift horse we must not look too closely in the mouth. For, with international oil prices in orbit, there might have been a problem meeting the import bill without running down reserves. Portfolio inflows have immeasurably shored up our forex resources and enabled us to carry on as if nothing has changed.

The RBI has started to breathe more easily on the monetary front. It has not moved the (benchmark) repo rate and the CRR stick was wielded before the policy itself.

The big news is undoubtedly the marked absence of dollar support operations in the last few weeks, allowing the rupee to appreciate sharply. It was the compulsion to check the rupee that created unwanted liquidity in the first place.

The RBI's hope and calculation must be that government spending will keep the market adequately supplied and the rising rupee will hold inflation in the desired range. While the former assumption could be right, an appreciating rupee may not necessarily translate to lower inflation. It all depends on the source of price pressures and the speed and scope of supply-augmenting strategies.

Going forward, a lot will ride on the monsoon. Normal rainfall should see containment of inflation risk. But, given the economy's growth momentum, the RBI cannot but exercise eternal vigil on the goods and asset price fronts and respond appropriately to any emerging problems.

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