RBI’s 79-page misreading

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: management, and instead, appears to suggest that all these are being effectively dealt with. The huge increase in liquidity that has resulted from RBI’s intervention in forex markets in its attempt to peg the rupee to a weakening dollar are hidden away in terms like “sizable accretions” to its forex assets. The report does not discuss why the net issuance of MSS bonds of Rs 1,05,691 crore during 2007-08 has proved to be inadequate in containing liquidity growth. It fails to clearly articulate why, instead of more open market operations, it has chosen to hike the CRR. While it discusses global liquidity conditions at length, there is no clarity on the impact it has had on interest differentials with India, on RBI’s responses in terms of capital controls, on the effectiveness of ECB/PN restrictions and other controls. In other words, there is excessive detail on things that do not matter, and little clear discussion on issues that do. This is consistent with RBI’s past policy of not being transparent or giving clear signals to the market. It evidently thinks that monetary policy is most effective when it surprises the market.

So, what might lie ahead? The CRR hikes indicate that RBI is finding it more and more difficult to sterilise its forex intervention using the preferred instrument of MSS bonds. In such a situation, any central bank would prefer to pump less liquidity into the economy. However, this will necessarily be a political decision. If the export lobby remains politically influential, we might see continued intervention in the forex market and more of the current difficulties. This could mean more CRR hikes for banks. However, if electoral politics comes to dominate the discourse, RBI may be able to step away from the forex market. While the direct impact of a rupee appreciation on prices may be limited to 1 or 2 percentage points, not having to buy up dollars will make RBI’s job of managing liquidity easier. Since the main source of liquidity is its forex intervention, the central bank would not be spending all its energy trying to mop up liquidity.