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RBI contains inflation by staying away from forex market
December, 21st 2009

The Reserve Bank of India (RBI) is trying to contain inflation by not intervening in the foreign exchange market. Though foreign investors have invested in huge amounts, the funds have not been formed a part of the apex bank's foreign exchange Kitty.

The latest RBI data reveals that between August and October this year, FIIs have invested around $8 bn in the country. Of this the regulator has absorbed only $ 336 million and sold the remaining in the forwards market.

Besides FII inflows, other sources of dollars are FDI, ECBs, export earnings and remittances. However, there is huge dollar demand from importers and investors to repatriate profits.

This is also helping the RBI contain inflation expectations as buying fewer dollars from the market results in lesser rupee funds being pumped into the system.

RBI is already trying to manage the excessive liquidity in the system as there is less credit demand amongst the people. The system has excess funds amounting to Rs.50,000 crore these days.

According to Shubhada Rao, chief economist, Yes Bank, "The Reserve Bank has already indicated that it is comfortable with the current pace of capital inflows and has therefore not intervened much in the foreign currency markets. This also serves not to exacerbate inflation expectations."

Soaring food inflation has raised concerns and a section of market feels that the easy monetary stance adopted by the RBI has contributed to the rising inflation.

"India's monetary exit will likely focus on first shrinking excess liquidity via multiple tools before normalising policy rates, probably from March/April 2010," said Rajeev Malik of Macquarie Economic Research in a recent report.

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