RBI governor defends capital controls

The faster recovery of emerging economies that triggered speculative capital flows into the developing world, largely from advanced economies, has resulted in currency appreciation unrelated to economic fundamentals. This posed complex policy management challenges for emerging economies, D Subbarao, governor of the Reserve Bank of India, said today.

He said capital flows have taken advantage of the early emergence of select emerging economies from the crisis as these economies began exiting from the crisis driven accommodative monetary stance ahead of the advanced economies.

This, he said, has posed complex policy management challenges with the currency appreciation eroding export competitiveness while also fuelling inflationary pressures.

Intervention in the forex market to prevent appreciation entails costs. This posed the dilemma of whether to liquidate the excess inflows or leave it to adjust itself

"If the excess liquidity is left unsterilised, it could potentially fuel inflationary pressures. If the excess liquidity is sterilised, it puts upward pressure on interest rates which not only hurts competitiveness, but also, in a curious variation of the Dutch disease, encourages further flows," Subbaro said while delivering the K R Narayanan oration.

While capital inflows far in excess of a country's absorptive capacity could pose problems other than currency appreciation, speculative flows looking for quick returns can potentially lead to asset price build-up, he pointed out.