Handling the Dollar Deluge

Context: At a time when import substitution and export growth are focus areas, the government may need a new strategy to maintain macroeconomic stability and currency management. 

Rising Challenges to the Indian Economy

• Surging Balance Sheet of the Reserve Bank of India: This has disrupted RBI’s calibrated approach to increasing the liquidity in the economy:
• The balance sheet has grown sharply to 27% of Gross Domestic Product (GDP) in early June from just 22% at the end of February.
• Management of the ‘Impossible Trinity’: The current economic situation makes it difficult to manage the following three parameters 
• Independent Monetary Policy: RBI has been forced to increase liquidity even when demand is declining.

• Excess money supply growth: The RBI has been forced to increase this pace even as nominal GDP growth has slipped to zero.
• Inflation of Financial Assets: In an economy with weak demand this may not drive consumer price inflation, but is likely to inflate prices of financial assets.
• High Gap between the weighted average lending rate of banks and the repo rate
• High Gap between bond yields and RBI’s repo rate.

• Free Capital Movement: Government is opening up the capital account through the following:

• Special category government bonds which will not have any limits on foreign ownership.
• Possible further relaxation in external commercial borrowing

• Fixing Foreign Rate Exchange: 

• Sharpening of Balance of Payments: Balance of Payment (BoP) surplus of $59 billion – about 2% of the GDP.
• Surplus Trade Deficit: This is majorly due to a fall in imports (gold and oil) and weak domestic demand.
• RBI forced to buy dollars to prevent the rupee from appreciating.

Way Forward:

• Reduction in the Cost of Capital: Encourage private firms to issue shares and raise funds by enhancing confidence in the economy.