India and loss of monetary policy autonomyopenlib.org/home/ila/TEACHING/IE_IIFT/sl_4_India_imposssible.pdf · monetary policy. India and loss ofmonetary policy autonomy – p. 35

India and loss ofmonetary policy autonomy

Ila Patnaik

April 2004

[email protected]

NCAER

India and loss ofmonetary policy autonomy – p. 1

http://openlib.org/home/ila

Outline

India’s openness on the capital account

Interest Parity

Forward market mispricing


Understanding monetary policy inepisodes of large currency trading by RBI


Reserves20

4060

80

Bill

ion

US

D

Aug 1994 May 1997 Feb 2000 Nov 2002

FX Reserves


Dating two interesting episodes

Based on this, we argue that there are two episodes thatmerit attention:

Episode 1: June 1993 to November 1994 (18 months)

Episode 2: August 2001 onwards


INR/USD35

4045

Rup

ees

per

US

D

Aug 1994 May 1997 Feb 2000 Nov 2002

INR/USD


Tightly pegged in both episodes0.

00.

20.

40.

60.

81.

01.

2

Dai

ly v

ol

1994−Aug 1997−May 2000−Feb 2002−NovIndia and loss ofmonetary policy autonomy – p. 7

Framework for understanding each episode

1. Initiation

2. Fluctuations of the currency

3. What was the currency forward market thinking?

4. Was RBI’s currency trading large compared with M0?

5. Sterilisation - OMO and reserve requirements

6. Overall impact on M3 and interest rates


Episode I


Initiation – capital market reforms, 1993

Foreign portfolio investment:

Period Inflow (Mln. USD)

Q2 1993-94 307Q3 1993-94 935Q4 1993-94 2283


Evolution of BOP in Episode I

(Billion USD)

Current account Net capital

Year balance Inflows

1991-92 -9.6 3.7

1992-93 -1.2 2.9

1993-94 -1.2 9.6

1994-95 -3.4 9.1

1995-96 -5.9 4.7

1996-97 -4.6 11.5


Sequence of events in Episode I31

.031

.532

.032

.5

Rup

ees

per

US

D

Dec 1992 Jul 1993 Feb 1994 Aug 1994 Mar 1995

INR/USD



.031

.532

.032

.5

Rup

ees

per

US

D

Dec 1992 Jul 1993 Feb 1994 Aug 1994 Mar 1995Dec 1992 Jul 1993 Feb 1994 Aug 1994 Mar 1995

−2

02

4

INR/USDForward mispricing (right axis)


Sequence of events in Episode I−

20

24

Per

cent

age

poin

ts


Forward mispricing


Sequence of events in Episode I−

20

24

Per

cent

age

poin

ts


020

0040

0060

0080

00

Forward mispricingRBI fx purchases (right axis)



2000

4000

6000

8000

Rs.

Cro

re


RBI fx purchases



2000

4000

6000

8000

Rs.

cro

re


1015

2025

30RBI fx purchasesM0 growth yoy (right axis)


Currency trading compared with M0

020

4060

8010

012

0

Per

cent


NFA / M0


Open market operations?

Data prior to January 1995 has not been published.


Limitations to OMO0

5010

015

020

0

Per

cent

Aug 1994 May 1997 Feb 2000 Nov 2002

Turnover ratio


Time-series of NFA and NDA50

000

1000

0015

0000

Leve

ls (

Rs.

cro

re)


NFANDAM0


Lever: Banking reserve requirements

Date Action

11-Jun-1994 Cash Reserve Ratio (CRR) was raised from 14% to

14.5%.

09-Jul-1994 CRR was raised to 14.75%.

06-Aug-1994 CRR was raised to 15%.

29-Oct-1994 CRR for Foreign Currency Non-Resident (FCNR) Ac-

counts was raised from 0% to 7.5%.

21-Jan-1995 CRR for Non-Resident accounts raised from 0% to 7.5%,

and CRR for FCNR accounts was raised to 15%.

17-Jul-1995 Conditions for overdraft facility to stock brokers to draw

money from banks were made more stringent.India and loss ofmonetary policy autonomy – p. 17

Monetary tightening4

68

1012

1416

Per

cent


91−day rateCRR


Overall impact on M0 and M3

1015

2025

30

Per

cent

age

chan

ge (

YO

Y)


Growth in M0Growth in M3


Summarising Episode I

1. Began as a surge in capital inflows.

2. NFA as percent of M0 went up from 20% to 45%.

3. NDA growth slowed, and reserve requirements wereused.

4. Yet M3 growth did accelerate.

5. Monetary tightening started in month 12, and impactedinterest rates well beyond.


Episode II


Initiation

(Billion USD)

Current account Net capital Change inbalance Inflows Reserves

1999-00 -4.7 10.2 +5.52000-01 -2.6 9.0 +4.32001-02 +1.4 9.5 +11.82002-03 +3.7 13.3 +21.32003-04 +36


Episode I versus II−

1000

00

1000

020

000

3000

0

Rs.

Cro

re

Nov 1991 Aug 1994 May 1997 Feb 2000 Nov 2002

Capital AccountCurrent Account


Sequence of events in Episode II45

.546

.046

.547

.047

.548

.048

.549

.0

Rup

ees

per

US

D

Mar 2001 Oct 2001 Apr 2002 Nov 2002 May 2003 Dec 2003

INR/USD


Sequence of events in Episode II45

.546

.046

.547

.047

.548

.048

.549

.0

Rup

ees

per

US

D

Mar 2001 Oct 2001 Apr 2002 Nov 2002 May 2003 Dec 2003Mar 2001 Oct 2001 Apr 2002 Nov 2002 May 2003 Dec 2003

−2

−1

01

23

4INR/USDForward mispricing (right axis)


Sequence of events in Episode II−

2−

10

12

34

Per

cent

age

poin

ts


Forward mispricing



2−

10

12

34

Per

cent

age

poin

ts

Mar 2001 Oct 2001 Apr 2002 Nov 2002 May 2003 Dec 2003Mar 2001 Oct 2001 Apr 2002 Nov 2002 May 2003 Dec 2003

−50

000

5000

1000

015

000

Forward mispricingRBI fx purchases (right axis)



5000

050

0010

000

1500

0

Rs.

Cro

re


RBI fx purchases


Currency trading compared with M0

020

4060

8010

012

0

Per

cent


NFA / M0


Feasibility of OMO0

5010

015

020

0

Per

cent

Aug 1994 May 1997 Feb 2000 Nov 2002

Turnover ratio


OMO versus currency trading−

1500

0−

5000

050

0015

000

Rs.

cro

re

Aug 1994 May 1997 Feb 2000 Nov 2002

OMORBI fx purchases


Time-series of NFA and NDA−

1e+

051e

+05

3e+

05

Leve

ls (

Rs.

cro

re)


NFANDAM0


Impact on interest rates4

68

1012

1416

Per

cent

Aug 1994 May 1997 Feb 2000 Nov 2002

91−day rate


Impact on interest rates4

68

1012

1416

Per

cent

Aug 1994 May 1997 Feb 2000 Nov 2002

91−day rateCRR


Overall impact on M0 and M3

68

1012

1416

18

Per

cent

age

chan

ge (

YO

Y)


Growth in M0Growth in M3


Summarising the first 3 years of Episode II

1. Began as a surge in the current account

2. After 6/2002, currency appreciation commenced,forward market forecasted appreciation, and capitalsurge commenced.

3. NFA as percent of M0 went up from 70% to 120%.

4. The bond market was actively used for OMO.

5. CRR phaseout program stayed on course; M3/M0 keptrising.

6. M0 and M3 growth did not accelerate.


VI. Comparing Episode I and Episode II


Episode II appears more benign

I II (thus far)

Initiation Capital account Current accountCurrency vol Mostly fixed Slight appreciationForward market Expected apprec. Expected apprec. from

7/02 onwards.NFA to M0 21% → 45% 70% → 120%CRR phaseout Abandoned UnaffectedBond market Weak Much improvedUse of OMO N.A. Strongly visible.M0 and M3 growth Accelerated Unaffected


But

Episode I ended in 1.5 years! Episode II has not endedyet.

The current account stayed negative in Episode I; but itturned positive in Episode II, adding to dollar inflows.

Attempts at reverting to some capital controls onexternal borrowing were overturned.

RBI will soon run out of bonds for OMO. ‘MarketStabilisation Bond’ plan.

RBI says the use of banking reserve requirments as aninstrument for sterilisation should not be ruled out.


Conclusion

The current account + private flows on the capitalaccount add up to roughly 55% of GDP.

Direct sterilisation is used by RBI to offset roughly 75%of the rise in NFA.

India’s currency peg has significantly attenuatedmonetary policy.


Conclusion

Private gross flows on the current and capital account atover 50 per cent of GDP.

Direct sterilisation through OMO appears to be the leastdistortionary.


Thank you


Documents

India and loss of monetary policy autonomyopenlib.org/home/ila/TEACHING/IE_IIFT/sl_4_India_imposssible.pdf · monetary policy. India and loss ofmonetary policy autonomy – p. 35