g padmanabhan : random payment system issues of systemic relevance for the new year keynote address by mr g padmanabhan, executive director of the reserve bank of india, to the bankers ’ club, thiruvanathapuram, 2 january 2013. * * * assistance provided by smt c s kar and saswat mahapatra in the preparation of the address and the comments / suggestions on the draft by s / shri g mahalingam, s ganeshkumar, a madhavan and smt radha somakumar gratefully acknowledged. it is always a pleasure to be in god ’ s own country to welcome the new year. i am thankful to the bankers club of thiruvanathapuram for affording this opportunity by inviting me over. i also deem it a privilege to be addressing the bankers of the state which recently captured the imagination of the nation when one of the districts – ernakulam – was declared as the first financially included district in the country. i am aware of the enormous efforts put in by the bankers in the state under the stewardship of our regional director shri. salim gangadharan. congratulations to the entire banking community of the state. the year that went by was quite challenging for the financial sector. the worsening of the sovereign debt crisis in europe and the unsteady recovery in the usa had posed significant risks to emerging markets like india, with domestic factors playing a major role - perhaps in balance a more decisive role in shaping the course of indian financial markets which remained volatile. as current account deficit burgeoned and reached a record high, debate on the contributory role of gold imports intensified. without getting into the thick of the debate, let me state two things. first, the argument that a central bank which had diversified its own assets into gold has no moral right to preach against investment / import of gold is missing an important point. a central bank diversifying its dollar reserves into gold is entirely different from private agents in a country having capital controls investing in gold as it has the same effect of allowing such assets to be held in foreign currency! it has to be clearly recognised that the central bank undertakes the onerous responsibility of managing the forex reserves of the country with the objectives of safety, liquidity and return in that order and investment in gold is in pursuit of these objectives! in the case of private savers, by stashing away his savings in gold, the economy stands to lose the benefit of

function of the anticipated persistence of capital inflows. the design of policy depends upon the expectation of whether the inflow of capital is temporary or is expected to continue. a temporary increase in inflow, perceived as such by the public, which may lead to a temporary real appreciation of the exchange rate, is unlikely to have major effects. problems, however, arise if the inflow is temporary, but the public expects the inflow to continue. but, in real life, nobody knows with confidence, what is temporary, how temporary it is, and what the public perception is, and indeed how temporary the public perception is! so, let me straightaway go into the instruments. internationally, a number of instruments have been used to sterilise capital inflows, the chief among them being the sale of government bonds through open market operations. this policy is useful temporarily and if used for long, leads to renewed inflows. we in the reserve bank are, however, well equipped with physical stock of government securities. we have been active in the repo market in recent months to manage temporary liquidity conditions. the idea is to realise a fine balance in order to achieve the objectives of sterilisation without putting pressure on yields. discount policy, which implies restricting the access of banks to central bank credit or raising the cost of refinance, has also been used by countries to sterilise capital inflows. this instrument cannot, however, be used in the current context when there is plenty of liquidity in the money market and there is no borrowing from the central bank. however, this instrument may go against the long - term objectives of monetary and credit policy. varying the reserve requirements is yet another policy tool. mobilising government deposits has served as a variation to absorption of reserves in some countries. variable deposit requirements in the nature of interest - free deposits with the central bank is another form of discouraging capital inflows. this measure, while it reduces the need for costly sterilisation through the sale of bonds, may result in misallocation of resources and reduce the facility to borrowers to take advantage of lower international interest rates. we have used the crr successfully in the past to stem inflows. after the imposition of crr on incremental nri deposits there has been some deceleration in the growth of foreign currency deposits during the current financial year. entering into foreign currency swaps ( spot sell - forward buy ) is