Foreign Currency Inflow in India

Paper Summary:

With increased globalization of the Indian economy, Reserve Bank of India's task of sterilization of inflows has become tough. There are costs attached to the sterilization operations. This paper analyzes the performance of this activity of the RBI and the benefits and costs of these operations. It tries to evaluate whether these operations are able to achieve the goal of keeping the inflation rate under check. It further discusses the justification for continuing these operations by the RBI and finally puts forth a case for establishing a Market Stabilization Fund in India. The paper foresees the future challenges that are likely to be faced by the RBI in view of the increasing inflow of foreign currency. As a corollary it also discusses the need to maintain large Forex reserve and the need to utilize a part of the reserve for investment in domestic sectors like infrastructure, health and education.

Outline
The Debt Stability Condition
Crowding Out, Fiscal Deficit, Absorption and Sterilization
Efficacy of Sterilization Operations
Policy Implications
Challenges to Financial Stability--Concluding Remarks

From the Paper:

"To overcome the great difficulties faced by the RBI to curb inflation due to excessive monetization, RBI, in 1997 reduced this mode of deficit financing to a considerable extent and resorted to Market Stabilization Scheme under which the GOI and RBI signed a MoU detailing the modalities of the MSS. This scheme came into effect from April 2004. Under the MoU the GOI would issue Treasury Bills and/or dated securities under the MSS in addition to normal borrowing requirements, for absorbing liquidity from the system. These securities will be issued by way of auctions to be conducted by RBI. These securities will be eligible for SLR and LAF operations also. Another very important feature of the scheme is that the payment for interest and discount will not be made from the MSS Account. "

Sample of Sources Used:

• Mohan Rakesh (2004): "Financial Sector Reforms: Policies and Performance Analysis", RBI Bulletin, November 2004.
• Jalan Bimal (2003): "Exchange Rate Management: An Emerging Consensus?" Address the 14th National Assembly of Forex Association of India on August 14, 2003, RBI Bulletin, September 2003.
• Reserve Bank Database.
• Charan Singh (2005): "Should India Use Foreign Exchange Reserves for Financing Infrastructure?", Stanford Institute for Economic Policy Research.

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