Monetary policy tomorrow: RBI going to walk tightrope
Oct 28 2013
Forwarding by 28 months and things haven’t changed much. Receding GDP growth still remains a problem and the RBI is still battling inflation. Linkages between monetary and fiscal policy are still discussed while expenditure continues to be high and household savings low. Question is where do we go from here as far as monetary policy is concerned?
It is likely that we won’t see any big bang measures in the near future. In the past few months, there has been a flurry of select activities by the Reserve Bank of India (RBI) in first stabilizing the currency and secondly bolstering the reserves through concessional measures. Gold imports have been tackled proactively and swap facilities have helped boost currency reserves. These steps were necessary and the RBI had to intervene to stabilize the currency. Now that global forex pressures have softened the RBI can afford to ease the throttle. However, the chronic problem of inflation still remains. The Wholesale Price Index (WPI) based inflation has risen four months continuously. Food prices have gone up especially that of vegetables and onion which has raised inflation for September to a 7 month high of 6.4 per cent. While growth-inflation conundrum still remains, the RBI seems to be clear that addressing inflation is a priority. Growth is secondary. A persistently high level of inflation in food and fuel still makes it tricky for further monetary easing.
In its earlier policy review in September, the RBI raised policy rate by 0.25 per to 7.5 per cent from 7.25 per cent. I expect the RBI to consider raising rates further to bring inflation under control. It is also likely that the RBI will not hesitate to raise rates further till the end of the fiscal cycle if it finds consumer prices to be sticky and inflation to persist. Some clarity from the RBI is also expected around its long term monetary measures. There is an expectation from the markets that rate cuts are good for boosting growth. Despite output remaining low, it is unlikely that the RBI will consider rate cuts soon. Therefore, expectation management is important. Anchoring inflation will continue to be the RBI’s focus.
Another area of focus remains liquidity. Earlier this year, the RBI had tightened liquidity to control rupee volatility. This was done with the intention of drying out liquidity and restraining speculation on the dollar. Since then, global conditions have softened and the RBI has passed on the benefit. The central bank reduced its marginal standing facility (MSF) rate by 50 basis points from 9.5% to 9.0% a few weeks back and announced its commitment to provide additional liquidity if required.
In my mind this is an important move as it shows that the RBI is balancing the repo hike with liquidity measures to keep rate impetus alive. This is a strategy that the RBI is likely to follow under the new governor.
In summary, macroeconomic conditions continue to be bleak and as a policy institution, the RBI is in the middle of it navigating a difficult period. Proactiveness is important and as seen in recent months, the RBI has been exemplary on this front. However, there is a limit to what the RBI can do. One must remember that given global volatility as seen over the past few years, the current soft external macro-economic environment will not prevail forever. US Fed’s much discussed tapering is also delayed and not withdrawn. Challenges are imminent and round the corner. What the RBI does then will dictate whether monetary policy is successful or not. These are indeed interesting times.
(Anis Chakravarty is a senior director at Deloitte Touche Tohmatsu India)