Post on 11-Oct-2020
India and loss ofmonetary policy autonomy
Ila Patnaik
April 2004
ipatnaik@ncaer.org
NCAER
India and loss ofmonetary policy autonomy – p. 1
Outline
India’s openness on the capital account
Interest Parity
Forward market mispricing
India and loss ofmonetary policy autonomy – p. 2
Understanding monetary policy inepisodes of large currency trading by RBI
India and loss ofmonetary policy autonomy – p. 3
Reserves20
4060
80
Bill
ion
US
D
Aug 1994 May 1997 Feb 2000 Nov 2002
FX Reserves
India and loss ofmonetary policy autonomy – p. 4
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
India and loss ofmonetary policy autonomy – p. 5
INR/USD35
4045
Rup
ees
per
US
D
Aug 1994 May 1997 Feb 2000 Nov 2002
INR/USD
India and loss ofmonetary policy autonomy – p. 6
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
India and loss ofmonetary policy autonomy – p. 8
Episode I
India and loss ofmonetary policy autonomy – p. 9
Initiation – capital market reforms, 1993
Foreign portfolio investment:
Period Inflow (Mln. USD)
Q2 1993-94 307Q3 1993-94 935Q4 1993-94 2283
India and loss ofmonetary policy autonomy – p. 10
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
India and loss ofmonetary policy autonomy – p. 11
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
India and loss ofmonetary policy autonomy – p. 12
Sequence of events in Episode I31
.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)
India and loss ofmonetary policy autonomy – p. 12
Sequence of events in Episode I−
20
24
Per
cent
age
poin
ts
Dec 1992 Jul 1993 Feb 1994 Aug 1994 Mar 1995
Forward mispricing
India and loss ofmonetary policy autonomy – p. 12
Sequence of events in Episode I−
20
24
Per
cent
age
poin
ts
Dec 1992 Jul 1993 Feb 1994 Aug 1994 Mar 1995Dec 1992 Jul 1993 Feb 1994 Aug 1994 Mar 1995
020
0040
0060
0080
00
Forward mispricingRBI fx purchases (right axis)
India and loss ofmonetary policy autonomy – p. 12
Sequence of events in Episode I0
2000
4000
6000
8000
Rs.
Cro
re
Dec 1992 Jul 1993 Feb 1994 Aug 1994 Mar 1995
RBI fx purchases
India and loss ofmonetary policy autonomy – p. 12
Sequence of events in Episode I0
2000
4000
6000
8000
Rs.
cro
re
Dec 1992 Jul 1993 Feb 1994 Aug 1994 Mar 1995Dec 1992 Jul 1993 Feb 1994 Aug 1994 Mar 1995
1015
2025
30RBI fx purchasesM0 growth yoy (right axis)
India and loss ofmonetary policy autonomy – p. 12
Currency trading compared with M0
020
4060
8010
012
0
Per
cent
Dec 1992 Jul 1993 Feb 1994 Aug 1994 Mar 1995
NFA / M0
India and loss ofmonetary policy autonomy – p. 13
Open market operations?
Data prior to January 1995 has not been published.
India and loss ofmonetary policy autonomy – p. 14
Limitations to OMO0
5010
015
020
0
Per
cent
Aug 1994 May 1997 Feb 2000 Nov 2002
Turnover ratio
India and loss ofmonetary policy autonomy – p. 15
Time-series of NFA and NDA50
000
1000
0015
0000
Leve
ls (
Rs.
cro
re)
Dec 1992 Jul 1993 Feb 1994 Aug 1994 Mar 1995
NFANDAM0
India and loss ofmonetary policy autonomy – p. 16
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
Dec 1992 Jul 1993 Feb 1994 Aug 1994 Mar 1995
91−day rateCRR
India and loss ofmonetary policy autonomy – p. 18
Overall impact on M0 and M3
1015
2025
30
Per
cent
age
chan
ge (
YO
Y)
Dec 1992 Jul 1993 Feb 1994 Aug 1994 Mar 1995
Growth in M0Growth in M3
India and loss ofmonetary policy autonomy – p. 19
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.
India and loss ofmonetary policy autonomy – p. 20
Episode II
India and loss ofmonetary policy autonomy – p. 21
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
India and loss ofmonetary policy autonomy – p. 22
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
India and loss ofmonetary policy autonomy – p. 23
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
India and loss ofmonetary policy autonomy – p. 24
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)
India and loss ofmonetary policy autonomy – p. 24
Sequence of events in Episode II−
2−
10
12
34
Per
cent
age
poin
ts
Mar 2001 Oct 2001 Apr 2002 Nov 2002 May 2003 Dec 2003
Forward mispricing
India and loss ofmonetary policy autonomy – p. 24
Sequence of events in Episode II−
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)
India and loss ofmonetary policy autonomy – p. 24
Sequence of events in Episode II−
5000
050
0010
000
1500
0
Rs.
Cro
re
Mar 2001 Oct 2001 Apr 2002 Nov 2002 May 2003 Dec 2003
RBI fx purchases
India and loss ofmonetary policy autonomy – p. 24
Currency trading compared with M0
020
4060
8010
012
0
Per
cent
Mar 2001 Oct 2001 Apr 2002 Nov 2002 May 2003 Dec 2003
NFA / M0
India and loss ofmonetary policy autonomy – p. 25
Feasibility of OMO0
5010
015
020
0
Per
cent
Aug 1994 May 1997 Feb 2000 Nov 2002
Turnover ratio
India and loss ofmonetary policy autonomy – p. 26
OMO versus currency trading−
1500
0−
5000
050
0015
000
Rs.
cro
re
Aug 1994 May 1997 Feb 2000 Nov 2002
OMORBI fx purchases
India and loss ofmonetary policy autonomy – p. 27
Time-series of NFA and NDA−
1e+
051e
+05
3e+
05
Leve
ls (
Rs.
cro
re)
Mar 2001 Oct 2001 Apr 2002 Nov 2002 May 2003 Dec 2003
NFANDAM0
India and loss ofmonetary policy autonomy – p. 28
Impact on interest rates4
68
1012
1416
Per
cent
Aug 1994 May 1997 Feb 2000 Nov 2002
91−day rate
India and loss ofmonetary policy autonomy – p. 29
Impact on interest rates4
68
1012
1416
Per
cent
Aug 1994 May 1997 Feb 2000 Nov 2002
91−day rateCRR
India and loss ofmonetary policy autonomy – p. 29
Overall impact on M0 and M3
68
1012
1416
18
Per
cent
age
chan
ge (
YO
Y)
Mar 2001 Oct 2001 Apr 2002 Nov 2002 May 2003 Dec 2003
Growth in M0Growth in M3
India and loss ofmonetary policy autonomy – p. 30
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.
India and loss ofmonetary policy autonomy – p. 31
VI. Comparing Episode I and Episode II
India and loss ofmonetary policy autonomy – p. 32
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
India and loss ofmonetary policy autonomy – p. 33
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.
India and loss ofmonetary policy autonomy – p. 34
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.
India and loss ofmonetary policy autonomy – p. 35
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.
India and loss ofmonetary policy autonomy – p. 36
Thank you
India and loss ofmonetary policy autonomy – p. 37