Saturday, October 16, 2010

Carry Trade and India's Dilemma

Times of India reports:

As Carry Trade (Foreign Direct Investments)  enter the markets, they are required to be converted into rupee to invest in India. The huge inflow of dollar makes US currency cheaper in the market, resulting in appreciation of rupee. But, in the process no extra rupee gets infused in the system. To avoid such appreciation of rupee, RBI buys the large forexes . But in this case, the rupee gets infused in system, leading to increase in liquidity. Increased liquidity leads to softening of interest rates, which, in turn, become inflationary.

The RBI may intervene in the foreign exchange market to stem the appreciation of rupee against dollar. But such an intervention will lead to infusion of liquidity in the system, forcing softening of interest rates, which will frustrate central bank's efforts to contain inflation. Annual inflation in September has inched up marginally to the uncomfortably high level of 8.63%.

RBI governor D Subbarao said on Friday said that the central bank will intervene if the inflows are lumpy and volatile. "We are watching the situation and our policy is clear. We will intervene if (FII) inflows are lumpy and volatile or they disrupt macro economic conditions.

Will India too impose controls on FDI like Brazil?

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