India is not insulated from global developments: RBI

India is not insulated from developments such as increased uncertainty about the prevailing condition in the US economy and continuing turmoil in global financial markets, cautioned the Reserve Bank of India.

While assuring stakeholders in the economy that it will respond quickly and appropriately to the evolving situation, the RBI said the downgrade of the US' sovereign rating has raised concerns as investors re-allocate portfolios in response to heightened risk perceptions stemming from both developments.

Credit rating agency Standard and Poor's downgraded the US rating from ‘AAA' to ‘AA+' on Friday last. Two other rating agencies, Moody's and Fitch, had recently maintained their AAA rating, but suggested that this could change.

While downside risks to domestic growth, which the RBI has pegged at 8 per cent in FY2011-12, may have increased in the wake of global developments, they are likely to have limited impact.

“As Friday's market behaviour demonstrated, India is not insulated from such developments. It may, however, be noted that in the worst phase of the recent global financial crisis, the economy grew by 6.8 per cent, suggesting high resilience emerging from domestic factors,” said the RBI.

The Reserve Bank, in a statement issued before the Indian financial markets opened on Monday, said it is closely monitoring all key indicators and will continuously assess the impact of global developments on the rupee and forex liquidity and macroeconomic stability.

If one reads between the lines the RBI statement indicates a pause in its tightening cycle, said Dr Brinda Jagirdar, General Manager & Head of Economic Research, State Bank of India.

Slack global growth will take the pressure off commodity prices and this in turn will help the central bank in its fight against inflation, she added. Further, a pause will support growth.

Near-term priority

In the near term, the Reserve Bank's priority is to ensure that adequate rupee and forex liquidity are maintained in domestic markets to prevent excessive volatility in interest rates and exchange rates, the central bank said.

Rupee liquidity is being provided through the repo window of the Liquidity Adjustment Facility (LAF). As of now, the banking system does not face any liquidity pressures as evident from the low level of dependence on liquidity injections under the LAF.

As regards forex liquidity, the Reserve Bank made an assessment of the ability of the forex reserve portfolio to meet potential forex requirements in the event of significant capital outflows. This exercise indicated that there were sufficient liquid reserves to meet the demand for forex even in stress scenarios.

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