Financial Stability Reports (FSR) of the Reserve Bank of India (RBI), March and December, 2010: A Critical Review with a Long-term Perspective

This article considers two aspects in the Reserve Bank of India’s (RBI) first set of reports on financial stability. First, the reports fear sudden and large flows of foreign capital, and rightly so. However, the focus of policy makers has been on foreign exchange reserves and on capital controls to some extent. This article explores the use of an additional instrument—the international credit line. Second, this article reconsiders the reasons for the correlation between stock prices and capital flows. There is some misunderstanding in the interpretation of the evidence. Finally, it is suggested that the government should gradually move in the direction of ‘prescription financial products’ to contain excessive volatility in financial markets. JEL Classification: F33, F41 and G01