Mint Roads white flag in war for Rs seen as sign of weakness

Written by fe Bureau | Mumbai | Updated: Jul 31 2013, 09:46am hrs
D SubbaraoD Subbarao, RBI governor
After shocking the markets with a double dose of liquidity tightening measures earlier this month, the Reserve Bank of India (RBI) on Tuesday sought to calm them, leaving key interest rates unchanged and indicating some of the measures aimed at checking volatility in the rupee may be rolled back in time.

The RBI move, however, appeared to have backfired with the rupee sliding sharply against the dollar in response to what was perceived as a weakened resolve to defend the currency; bond yields rose.

The recent liquidity tightening measures by the Reserve Bank of India are aimed at checking undue volatility in the foreign exchange market and will be rolled back in a calibrated manner as stability is restored to the foreign

exchange market, the RBI said in its guidance on monetary policy.

Together with the falling rupee, the RBIs lower forecast for growth in 2013-14 of 5.5%, down from the earlier 5.7%, disappointed equity markets the Sensex tumbled 245 points. The central bank, however, retained its outlook for wholesale price-based inflation at a level of 5% by March 2014, although it flagged upside risks to inflation on account of the weaker currency.

Bankers cautioned they may have to raise lending rates if the RBIs measures lasted longer than a few weeks, adding to the gloom. I think two to three weeks is the normal waiting time after which we will have to take a call, State Bank of India chairman Pratip Chaudhuri said.

C Rangarajan, chairman of the Prime Ministers Economic Advisory Council, told a television channel in response to the RBIs policy, Withdrawal of these measures will depend on the return of normalcy to forex markets. As and when capital flows return, the RBI should be able to roll back.

The central bank downplayed the possibility of a sovereign bond issue suggesting it was not appropriate at the current juncture. In the Reserve Banks view, costs of a sovereign bond issue, especially at the current juncture, outweigh the benefits. We should be doing a sovereign bond issue, if at all, when we are much less vulnerable than we are at this time, RBI governor D Subbarao said at a press conference after the policy announcement.

Acknowledging the country is facing headwinds on all fronts, the central bank said India was caught in a classic impossible trinity of trying to manage its exchange rate, free capital movement and yet maintain an independent monetary policy. The rupee closed 1.8% lower at 60.485 erasing the gains seen in the currency since the RBI first initiated liquidity tightening measures on July 15 to curb the volatility in the currency. Bond yields, too, spiked in response to the weakness and closed at 8.24% despite the possibility of a roll-back in the RBIs liquidity measures.

For now, the cash reserve ratio (CRR) maintained by banks remains at 4% while the key policy rate the repo rate was also left unchanged at 7.25%.

The marginal standing facility (MSF) rate which was hiked to 300 basis points above the repo rate earlier this month, remains at 10.25%.

While keeping rates steady, the RBI hinted it may resume its rate easing cycle with the RBI saying stability in the currency markets would enable monetary policy to revert to supporting growth with continuing vigil on inflation. We want to revert to supporting growth as much as anyone else. Now that wholesale inflation has ebbed, there is a strong case to support growth, Subbarao said adding that space to support growth was being constricted by the volatility in the currency.

Projection for credit growth and deposit growth was maintained at 15% and 14% respectively. Currently, both indicators are trending below the RBIs projections with credit growing at 14.2% for the fortnight ended July 12 and deposits growing 13.7%.

The recent liquidity tightening measures have only provided a breather, the RBI said, adding structural measures would be needed to bring CAD down to sustainable levels.

The RBI also continues to monitor levels of speculative activity in the forex markets onshore and offshore in the non-deliverable forwards market (NDF) which the central bank believes could be compounding the problem for the currency.

One thing we are trying to do in the currency futures market, there is a lot of position-taking which we have curtailed and by month-end, this would reduce hopefully. If not, further measures would be taken. There is a connect between NDF market and the futures market, said HR Khan, deputy governor, RBI.

The governor, however reiterated that the central bank was not trying to defend any level on the rupee which remains vulnerable due to the high current account deficit and the possibility of a reversal in capital flows due to the possible tapering of the US Federal Reserves quantitative easing programme.

Indias CAD widened to a record of 4.8% in FY13 and while it is expected to ease below those levels in the current fiscal, it remains above the indicated sustainable level of 2.5% of GDP.

While currency and external sector concerns dominated the first quarter review of monetary policy, the central bank remains mindful of the persisting weakness in growth in the economy. Along with reducing its growth forecast, the central bank says that the investment climate remains weak and risk aversion continues to stall investment plans. Cost and time overruns along with high leverage, deteriorating cash flows, erosion of asset quality and muted credit confidence could emerge as further downside risks to growth, says the RBI.