Capital flows key to rupee trend, says RBI deputy governor

The Reserve Bank of India (RBI) is pinning hopes on improvement in capital inflows to check rupee volatility even as it concedes that there are pressures in the system which limit the room for reducing interest rates further.

“When we look at rupee dynamics for the last six months, the fundamental driver is the current account deficit. The demand for dollars is coming from oil, gold and other imports. From late October to early January, there was sustained pressure on rupee through financing of imports. When we look back, October, November and December was a pressure period. Though there was some change in January and February, from March a similar situation repeated. Capital flows have dwindled and the demand on current account has remained very strong,” Subir Gokarn, RBI deputy governor, said.

At a programme organised by industry body Ficci, he said capital inflows held the key for determining the currency.

“The main driver for capital inflows is going to be the improvement in the perception on the investment climate and the policy measures on the fiscal front. Currency now is going to be determined based on how quickly and how sharply the capital inflows revive,” he said.

Describing current account and balance of payment as stress points currently, the deputy governor said the apex bank would target a rate for the currency. “But we are conscious of extreme volatility and it can be disruptive. But the ultimate determinant on the exchange rates is going to be how much capital comes in and finances the current account deficit,” he said.

According to Gokarn, inflation is still outside comfort zone but is showing signs of easing. “Risks are still there; whether it is commodity pricing, absence of fiscal correction, rupee depreciation, etc we will address them as they materialise. But in our base-plan scenario, we expect the growth to be slightly better in 2012-13 than in 2011-12. Inflation would be somewhat moderate,” he said.

However, the expectations on interest rate cut are likely to be short-lived with the central bank being wary of inflationary pressures.

“There are still some inflationary pressures. That in a way limits our room to reduce interest rates. That does not mean there is no room at all but there is limited room to do that,” he said.