The need to support the rupee has become an urgent task, overshadowing the traditional policy objectives of growth and price stability.

Meeting almost universal expectations, the Reserve Bank of India, in its review of monetary policy for the first quarter of 2013-14 (April-June, 2013), did not alter the repo rate, the marginal standing facility rate, as well as the cash reserve ratio (CRR). All the relevant rates remain unchanged. By being predictable, did the RBI make the quarterly policy statement a non-event?

To seek an answer, one has to remember that maintaining the status quo, by itself, can send more powerful messages than a cut or a hike in the repo rate. It all depends on the context in which the policy review is framed.

Clamping down on liquidity

This time the falling rupee, which has been weighing with all policymakers (not just the RBI), naturally came to occupy the centre stage. Over a fortnight before the policy statement, the central bank clamped down on liquidity in the system after restricting finance available to banks, and steeply increasing the marginal standing facility rate to 10.25 per cent, three percentage points above the repo rate. The idea was to squeeze out liquidity, which, the RBI believed, aided ‘excess’ speculation in the forex markets.

In effect, the RBI tightened the monetary policy without having to go through the rigmarole of more conventional measures — hiking the repo and/or the CRR. That the central bank was criticised for being opaque and adopting a roundabout method, when a straight repo rate hike would have served the purpose, is a different matter. What seemed to matter was that for at least two weeks, the RBI’s measures worked. The rupee was bottled up in a narrow range of 59 to 60 to the dollar. However, on the very day the policy was announced (July 30), the rupee fell sharply to breach the psychological barrier of 60, closing the day at 60.48, 105 paise below the previous day’s closing.

Stable rupee, prime concern

Obviously that has upset the RBI’s plans. But before speculating on what next, it would be useful to reiterate that this policy was not focussed on interest rate changes. A stable rupee has become the prime concern of everyone of consequence. In such a context, a repo rate cut was simply not on.

Besides, it would have run counter to the liquidity curbing package and sent out highly confused signals.

As for the third option — a rate hike — which looked improbable just a few weeks earlier, suddenly came to be a serious option but given the state of the political economy could not be pursued. That is why for the RBI maintaining the rate became the only viable course.

Henceforth, the focus will be on the rupee and what extra measures would be needed to defend it. Here a number of views have emerged ranging from fixing the burgeoning current account deficit — perhaps the only long range solution — to acknowledging that the rupee needs to settle down at a more ‘appropriate’ level, say, 65 to the dollar.

The urgent task

In its guidance — the most widely read part of the policy document — the RBI has this to say: “While certain crucial indicators — moderating wholesale price inflation, good monsoons and decelerating growth — would suggest an easing of interest rates, the need to support the rupee has become an urgent task, overshadowing the traditional policy objectives of growth and price stability.” Retreating from the recent liquidity measures will be considered only after stability is restored in the foreign exchange markets. Only then will it have the space to address growth concerns without compromising on inflation.

Nothing to stimulate growth

The guidance has been criticised for being vague, not defining the exact parameters that will denote stability. At what level should the rupee settle down and for how long? These are difficult questions to answer even in less abnormal times but when financial markets, including stock markets, spiralled down after the policy statement in defiance as it were, there are special reasons to worry.

All sorts of theories are going around as to why the markets tanked. The ‘dovish’ tone of the policy is interpreted as a sign of weakness, leading to a sell off.

On the other side, there is disappointment that the RBI has done nothing to stimulate growth even though it lowered its growth forecast.

The RBI should strive to regain credibility to win the battle for a stable rupee.

narasimhan.crl@thehindu.co.in

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