RBI to intervene in forex market only to curb volatility

Amid rupee crossing the 57 mark against US dollar, the Reserve Bank said on Friday it is not targeting any exchange rate but will intervene in the forex markets only to curb volatility and prevent disruption of macroeconomic stability.

"In India, the RBI does not target any exchange rate. We intervene in the foreign exchange market only to manage the volatility and to manage the disruption to the macro economic situation," RBI Governor D Subbarao said.

He was delivering a lecture organised in Hyderabad by Institute of Public Enterprise.

Subbarao said: "The important point is that we have to be internally sure that when we enter market we are credible because for a central bank failed defence of exchange rate can be quite detrimental.

"When you have downward pressure on the rupee as I said you have to shell your dollars.

"And a fair defence of the exchange rate can be worse than no defence." The rupee weakened below 57 to the dollar on Friday to approach a record low hit about a year ago.

It was trading at 57.06/07 to the dollar.

The Indian currency had hit record low of 57.32 against a dollar in June last year.

On the widening Current Account Deficit, Subbarao said there are three concerns about India’s CAD.

These are quantum of CAD, quality of CAD and financing the CAD.

The increase in the deficit above the sustainable levels year-on-year is certainly going to add the pressure, he said.

Subbarao said the quantum of CAD is a concern because as per the RBI estimates the sustainable CAD for India, with reasonable assumptions, should be 2.5-3 per cent of gross domestic product.

As for the quality of CAD, he said: "If the imports are meant for capital goods, it is encouraging as it may increase productivity in future. But we are having high CAD because we are importing gold and it will be dead-weight and cause of concern.

"Textbook economics tells us if the growth is decelerating, the CAD must adjust. That's not happening in India. . . .

It is because of oil and gold imports which are price inelastic. Second, gold import as a hedge against inflation in the last three years."

In order to restrain the import of gold, Subbarao said, the RBI and the government have taken several steps in the past six months.

This week, the government raised customs duty on gold to 8 per cent from 6 per cent to curb the demand for the metal.

Subbarao said India needs equity capital flows to finance the CAD but that is not always happening.

"Inflation has come off-peak. Current Account Deficit is recording high and most disturbing is investments have decelerated," he added.

He said there are three policy challenges for the Indian economy -- managing the growth-inflation dynamics, mitigating the vulnerability of the external sector and managing the political economy of fiscal consolidation.

Allaying fears of twin deficits -- fiscal deficit and the current account, Subbarao said: "Most importantly, unlike in 1991, in 2012-13, our exchange rate is market determined.

"Our financial markets are deep and resilient.

"Therefore, its unlikely that we will have a problem of the 1991 type.

"To everyone's relief, the government has embraced fiscal consolidation once again."

Last year, fiscal deficit was at 4.9 per cent of the GDP.

The latest number was much lower than most people thought it might be, he said.

Image: RBI Governor D Subbarao