Article 3: Needed: More stable foreign capital
Why in news: RBI measures to boost foreign capital have generated unexpectedly large inflows, strengthening forex reserves and external stability while creating excess liquidity and highlighting India’s continuing need for stable investment.
Key Details
- Large inflows: Forex swap-related inflows reached $136.3 billion by August 31.
- FCNR(B) dominance: Around $127 billion came through FCNR(B) deposits.
- Forex reserves: India’s reserves reached a record $729 billion by August 21.
- Liquidity surplus: Excess banking-system liquidity rose to about ₹6.7 lakh crore.
- Underlying concern: Temporary inflows cannot replace the need for stable FDI and stronger fundamentals.
RBI Measures and Surge in Capital Inflows
- In June, the RBI introduced measures to increase foreign capital inflows into India.
- Initial concerns centred on whether these measures could attract sufficient funds amid tight global financial conditions.
- By August 31, inflows through the forex swap facility reached $136.3 billion, significantly exceeding expectations.
- Around $63.5 billion entered during the final 10 days, showing a sharp acceleration.
- The surge demonstrates strong investor response to the RBI’s measures.
FCNR(B) Route Drives the Inflows
- The FCNR(B) route contributed around $127 billion of the total inflows.
- The remaining amount came through External Commercial Borrowings (ECBs) and Overseas Foreign Currency Borrowings.
- Strong foreign-currency inflows have strengthened India’s external liquidity position.
- Forex reserves increased to a record $729 billion as of August 21.
- Higher reserves provide greater protection against external shocks and exchange-rate volatility.
Rising Liquidity Creates RBI Management Challenges
- Large capital inflows have increased surplus liquidity in the domestic financial system.
- The liquidity surplus rose from over ₹3 lakh crore in early August to ₹6.7 lakh crore by month-end.
- Excess liquidity can complicate the RBI’s efforts to maintain appropriate monetary conditions.
- The RBI has used Variable Rate Reverse Repo (VRRR) auctions to absorb surplus liquidity.
- If inflows remain strong, the RBI may need to deploy additional liquidity-management instruments.
Inflation and Monetary Policy Concerns
- The liquidity surge coincides with rising inflationary pressures in the economy.
- Excess liquidity could make inflation management more challenging for the RBI.
- There are expectations that the Monetary Policy Committee (MPC) may need to raise interest rates.
- Strong economic growth in the first quarter could provide the MPC greater confidence to pursue monetary tightening.
- The RBI must balance inflation control, liquidity management, growth and external stability.
Temporary Relief, But Structural Issues Remain
- FCNR(B) inflows have helped slow the rupee’s depreciation and strengthen India’s external position.
- However, these inflows do not resolve India’s underlying current account deficit or shortage of stable foreign investment.
- Foreign portfolio investors have recently become net buyers, while net FDI is gradually improving.
- Tighter global financial conditions could still reduce the availability of foreign capital.
- India therefore needs structural reforms and a stronger investment environment to attract stable, long-term foreign capital.
Conclusion
The surge in foreign-currency inflows has strengthened India’s external position and supported the rupee, but it also creates liquidity-management challenges for the RBI. More importantly, such inflows cannot substitute for sustainable foreign investment. India must address its current account deficit, improve investment conditions and strengthen economic fundamentals to attract stable, long-term capital, particularly during periods of tighter global financial conditions.
Descriptive question:
The surge in foreign capital inflows has strengthened India’s external position but has also created liquidity-management challenges for the RBI. Discuss the opportunities and risks associated with such inflows. (150 words, 10 marks)
Source: The Indian Express