of capital flows to countries in 2009 with a strong growth outlook or appreciation expectations brought back pressures on the exchange rate and rising asset valuations, including equities ( chart 5 ). many emerging markets met these challenges with a mix of macroeconomic policies as well as macro - prudential and other capital flow management measures. let me now turn to the indian experience in managing the spillover from volatility in capital flows. indian experience we have a deficit in the current account of our balance of payments ( bop ). hence, we are dependent on global financial markets to finance our current account deficit ( cad ). the impact of capital flow volatility on our economy can best be captured in a snapshot by looking at the movement in our foreign exchange reserves and the exchange rate ( chart 6 ). lane, timothy ( 2012 ), “ financing commodities markets ”, remarks at the cfa society of calgary, calgary, alberta, 25 september 2012. bis central bankers ’ speeches we experienced a phase of high growth and low inflation prior to the crisis. financing the current account was not an issue for two reasons : first, the cad was small and second, capital inflows were far in excess of the absorptive capacity of the economy. hence, capital inflows resulted in both the appreciation of the rupee and accretion to foreign exchange reserves. in the context of intervention in the foreign exchange market, the issue of cost of sterilisation invariably comes up for discussion. but the issue is a complex one : should one look purely at the financial cost measured largely in terms of interest rate differential between foreign and domestic interest rates? should one look at the cost of non - intervention in terms of its implications for financial stability, which is of course difficult to quantify but perhaps easy to understand? in any case, the financial cost of sterilisation is in the nature of a quasi - fiscal cost : if it is borne by the central bank, profit transfer to the government reduces to that extent ; if it is directly borne by the government, it is reflected in the budget. in addition, if sterilisation is done through raising unremunerated cash reserve ratio ( crr ), the cost is borne by commercial banks, though they may benefit from easy liquidity. in its intervention operations, the reserve bank followed a cost sharing approach with the financial costs shared by the rbi, government and commercial banks. with the hindsight i could venture to say that the liquidity

buffers that were built up earlier helped during the crisis. deleveraging during the crisis led to reversal of capital flows. india ’ s balance of payments came under pressure in q3 of 2008 – 09 due to capital outflows. it became necessary to draw down reserves to finance the shortfall and maintain orderly conditions in the foreign exchange market. this led to a corresponding contraction in the base ( reserve ) money. the reserve bank, therefore, ensured the necessary expansion in net domestic assets ( nda ) through conventional open market operations ( omo ) involving outright purchase of government securities in the secondary market as well as provision of liquidity through repos under its daily liquidity adjustment facility ( laf ). bis central bankers ’ speeches another instrument, which allowed the reserve bank to expand liquidity, was the unwinding of the market stabilisation scheme ( mss ) securities5. the unwinding of mss balances not only created the scope for adequate liquidity expansion by the reserve bank without expanding its balance sheet in any significant measure, but the timing of the unwinding could also be modulated in such a way that the large borrowing programme of the government was managed smoothly without exerting undue market stress. in addition, the reduction in cash reserve ratio ( crr ) of banks from 9 per cent to 5 per cent released 1. 6 trillion of primary liquidity. liquidity expansion achieved through unwinding of mss and reduction in crr ensured that the reserve bank ’ s balance sheet did not expand significantly, unlike in several other central banks. thus the liquidity buffer built up in the pre - crisis period helped to ease both foreign exchange and rupee liquidity. since india witnessed stronger growth ahead of the global recovery, capital inflow revived during 2009 – 10 and 2010 – 11 and was reflected in significant appreciation of the rupee. it was also supported by ample global liquidity conditions emanating from quantitative easing ( qe ). however, during the euro area crisis, deleveraging in european banking system again adversely affected capital flows to india towards the later part of 2011 – 12. in response, several policy measures were taken to encourage capital inflows, particularly giving greater access to international investors to domestic currency debt market. again, volatility in the financial market returned following the announcement in may 2013 of the us fed ’ s intention of likely tapering of qe. portfolio outflows, particularly from the domestic