In line with expectations, the first quarter monetary policy maintained status quo on key policy rates and attempted to provide a rationale for its measures taken earlier. In terms of communicating the timing of a rollback, RBI chose to link the reversal of the recent tightening measures to stability in the foreign exchange market, unlike the Fed, which provided a quantitative guidance to roll back QE-3. In the absence of any quantitative guidance here, the interpretation of foreign exchange market stability may vary and, thus, could leave markets in a constantly guessing mode.
Although the domestic liquidity tightening measures are intended to curb exchange rate speculation, we believe the rupee may also continue to react to announcement effects of Fed and crude oil prices. This, along with continuing weakness in CAD, will keep rupee on a weaker turf.
It is imperative that government intensifies its efforts to contain CAD through structural and administrative measures like steeper hikes in administered fuel prices, raising import duties on discretionary consumption items and reducing dependence on imported coal, among others. Absence of a lead role by the government could compel RBI to delay the reversal of the recent tightening measures. A prolonged continuation of such measures could prove detrimental to recovery in growth and in turn to domestic financial stability.
Meanwhile, it is important to ensure that the concerns on funding of CAD are mitigated by exploring options like issuance of NRI bonds. Stable and lumpy inflows from NRIs would shore up foreign exchange reserves and allow time for the government to initiate structural reforms to impart external sector strength.
While the merit of RBI measures is well appreciated, it is critical to focus on bolstering growth through a revival in investment climate as improved fundamentals alone would enable us to attract durable capital flows. As such, government needs to further step up its efforts to clear hurdles impeding stalled projects.
The current macroeconomic environment demands a self-imposed urgency in addressing growth concerns by the government. Clearly the government needs to take the lead, with RBI subsequently complementing with resuming its easing monetary cycle. It would not serve the purpose if RBI is made to walk the path alone.
The writer is chief economist, Yes Bank