It is not surprising that the Reserve Bank of India’s decision to tighten liquidity in the system last week has been met with umbrage on grounds that we may be choking growth for a longer period of time. Given that there was hope that RBI will lower interest rates with relatively low inflation numbers, this move comes as a shocker. RBI becomes the favourite whipping boy for everyone because it has become fashionable for market players to expect the central bank to do everything to please it, and when this does not happen, there is resentment. But RBI has to look beyond the markets.
There is a method in the measures that have been taken so far by the central bank to tackle the falling rupee. It started on the exporter’s side in May to ensure that they bring in their earnings. Gold import curbs were next imposed on trading agencies. Telcos were allowed to refinance rupee loans and low-cost builders could access the ECB route. Buyback period for FCCBs was extended next and further curbs put on banks with respect to gold dealings. Provisioning requirements were imposed on banks dealing with corporates with unhedged forex positions and limits were increased on derivative trading. Therefore, the present liquidity curbs are just another step in this direction and should be interpreted within this context and not as an isolated instance of tinkering with the money market. In fact, further curbs have been imposed on gold imports by linking them with exports. Quite clearly, it has been a calibrated approach to tackling the problem.
Will these measures work? To the extent that the rupee is driven by such events and sentiments, there is an impact as was seen by the rupee regaining ground. But it becomes mean reverting in the range of 59-60, which has been the case in the past too. It has happened again this time, meaning thereby that these measures have had a limited impact on the market. The impact of any such measure is transient, but it does successfully address the objective of curbing speculative activity to the extent that it was present.
Now, the R75,000 crore norm under LAF is not really out of sync with RBI’s often stated stance that repo borrowings should not be more than 1% of NDTL. Besides, when there is adequate liquidity in the market, there is little reason for the repo window to get a long line of customers. In fact, a couple of years ago, RBI had cautioned on excess borrowing from this window by banks where funds were being diverted for lending which could create an ALM problem. One can guess that this measure is temporary as the purpose is to ensure that this liquidity does not flow into the forex market. Once RBI is convinced, one can expect a walk back on this measure. Similarly, increasing the MSF rate is pragmatic as once banks borrow at 10.25% there will be less scope for using it for speculative purposes, to the extent that it was happening.
Where does this leave us? The panic in the markets lasted a few days and the fact that the OMO and T-bills auctions did not elicit the desired response shows that either banks wanted better yields under the given conditions or that there was no excess liquidity in the system to begin with. However, banks which rely on short-term funds will face the brunt though it is unlikely that long-term rates will move up across the board. The call market will become volatile and the band will be 7.25% to 10.25% with pressure mounting in the reporting fortnights. Liquidity should not really be an issue. RBI data show that in the first quarter of the year, deposits increased by R3,397 billion while credit increased by R1,546 billion and investments by R1,307 billion as of June-end. Therefore, there is no fundamental threat to the credit process, which is normally muted till August-September. The GSec yields have become volatile with the 10-year yield hitting the 8% mark in a short while. It looks like that this scene will last till the end of the month, when RBI comes out with its policy statement where a stance and view will be provided.
RBI is really on what can be considered the prudent path given the state of the economy. True, the economy is stagnating as the latest industrial growth numbers show. But that is not RBI’s fault and whenever it has lowered rates to please the markets, the response has been lukewarm. Merely lowering interest rates does not lead to growth as not only is the transmission mechanism not efficient, but so is the demand situation. Capacity utilisation data collated by RBI show that the rate is around 75% as of December and, therefore, there is less of a need to invest when demand conditions are low and interest rates high. Consumers are not spending because they have to allocate a larger part of their income for food items. Therefore, there is a view that we should unbundle the issues and not read too much into the growth aspect of these moves, howsoever tempting it may be.
What about policy rates? RBI has been targeting inflation which has largely been driven by food and fuel prices. Core inflation was under control and has reached one of its lowest levels in June even though generalised inflation has inched up. This does not provide comfort because the impact of imported inflation, which will be primarily in fuel and manufactured items, has not yet been felt. RBI will hence have to wait and watch before taking any call on interest rates. Further, given that the rupee is slippery and FIIs are in a sell mode on the debt side, retaining interest rates at the present level may not exactly be a deterrent, but lowering it would hasten the outflow.
This brings us to the final point: how important then is the exchange rate considering that all efforts are on to control the slide in the rupee even though industry feels we are barking up the wrong tree and impeding growth. We have had several measures invoked to control the rupee slide and RBI has also sold dollars in the market—with limited success. An alternative extreme thought could be why not allow the rupee to find its own level, say, R70 per dollar. Automatically imports of non-essentials will diminish and the CAD will improve. The only fear is that while inflows gain, outflows lose and this can be a dangerous trigger for FIIs which can exacerbate the situation. This being the case, it becomes more essential for us to keep control over the rupee so that stability is maintained in an otherwise fragile balance of payments state.
The central bank has a difficult role here. If it does nothing on the rupee, it is damned. If it does something, which invariably means pain somewhere else, it is damned again. Not really the best of the positions to be in.
There is a method in the measures that have been taken so far by the central bank to tackle the falling rupee. It started on the exporter’s side in May to ensure that they bring in their earnings. Gold import curbs were next imposed on trading agencies. Telcos were allowed to refinance rupee loans and low-cost builders could access the ECB route. Buyback period for FCCBs was extended next and further curbs put on banks with respect to gold dealings. Provisioning requirements were imposed on banks dealing with corporates with unhedged forex positions and limits were increased on derivative trading. Therefore, the present liquidity curbs are just another step in this direction and should be interpreted within this context and not as an isolated instance of tinkering with the money market. In fact, further curbs have been imposed on gold imports by linking them with exports. Quite clearly, it has been a calibrated approach to tackling the problem.
Will these measures work? To the extent that the rupee is driven by such events and sentiments, there is an impact as was seen by the rupee regaining ground. But it becomes mean reverting in the range of 59-60, which has been the case in the past too. It has happened again this time, meaning thereby that these measures have had a limited impact on the market. The impact of any such measure is transient, but it does successfully address the objective of curbing speculative activity to the extent that it was present.
Now, the R75,000 crore norm under LAF is not really out of sync with RBI’s often stated stance that repo borrowings should not be more than 1% of NDTL. Besides, when there is adequate liquidity in the market, there is little reason for the repo window to get a long line of customers. In fact, a couple of years ago, RBI had cautioned on excess borrowing from this window by banks where funds were being diverted for lending which could create an ALM problem. One can guess that this measure is temporary as the purpose is to ensure that this liquidity does not flow into the forex market. Once RBI is convinced, one can expect a walk back on this measure. Similarly, increasing the MSF rate is pragmatic as once banks borrow at 10.25% there will be less scope for using it for speculative purposes, to the extent that it was happening.
Where does this leave us? The panic in the markets lasted a few days and the fact that the OMO and T-bills auctions did not elicit the desired response shows that either banks wanted better yields under the given conditions or that there was no excess liquidity in the system to begin with. However, banks which rely on short-term funds will face the brunt though it is unlikely that long-term rates will move up across the board. The call market will become volatile and the band will be 7.25% to 10.25% with pressure mounting in the reporting fortnights. Liquidity should not really be an issue. RBI data show that in the first quarter of the year, deposits increased by R3,397 billion while credit increased by R1,546 billion and investments by R1,307 billion as of June-end. Therefore, there is no fundamental threat to the credit process, which is normally muted till August-September. The GSec yields have become volatile with the 10-year yield hitting the 8% mark in a short while. It looks like that this scene will last till the end of the month, when RBI comes out with its policy statement where a stance and view will be provided.
RBI is really on what can be considered the prudent path given the state of the economy. True, the economy is stagnating as the latest industrial growth numbers show. But that is not RBI’s fault and whenever it has lowered rates to please the markets, the response has been lukewarm. Merely lowering interest rates does not lead to growth as not only is the transmission mechanism not efficient, but so is the demand situation. Capacity utilisation data collated by RBI show that the rate is around 75% as of December and, therefore, there is less of a need to invest when demand conditions are low and interest rates high. Consumers are not spending because they have to allocate a larger part of their income for food items. Therefore, there is a view that we should unbundle the issues and not read too much into the growth aspect of these moves, howsoever tempting it may be.
What about policy rates? RBI has been targeting inflation which has largely been driven by food and fuel prices. Core inflation was under control and has reached one of its lowest levels in June even though generalised inflation has inched up. This does not provide comfort because the impact of imported inflation, which will be primarily in fuel and manufactured items, has not yet been felt. RBI will hence have to wait and watch before taking any call on interest rates. Further, given that the rupee is slippery and FIIs are in a sell mode on the debt side, retaining interest rates at the present level may not exactly be a deterrent, but lowering it would hasten the outflow.
This brings us to the final point: how important then is the exchange rate considering that all efforts are on to control the slide in the rupee even though industry feels we are barking up the wrong tree and impeding growth. We have had several measures invoked to control the rupee slide and RBI has also sold dollars in the market—with limited success. An alternative extreme thought could be why not allow the rupee to find its own level, say, R70 per dollar. Automatically imports of non-essentials will diminish and the CAD will improve. The only fear is that while inflows gain, outflows lose and this can be a dangerous trigger for FIIs which can exacerbate the situation. This being the case, it becomes more essential for us to keep control over the rupee so that stability is maintained in an otherwise fragile balance of payments state.
The central bank has a difficult role here. If it does nothing on the rupee, it is damned. If it does something, which invariably means pain somewhere else, it is damned again. Not really the best of the positions to be in.
No comments:
Post a Comment