Raghuram Rajan, who recently took over as governor of the Reserve Bank of India, has been eloquent on financial reforms in his inaugural speech. This is to be distinguished from monetary policy action, which will be revealed on September 20. The head of the country’s central bank has spoken on monetary policy, financial markets, inclusive banking, internationalisation of the rupee, debt recovery, and financial infrastructure, among other things. The impact of this has improved sentiment, in terms of the rupee becoming stronger and bond yields moving down. But to really witness positive effects, monetary policy holds the key. The ideas referred to publicly affect the periphery. This is needed as sentiments drive markets to a large extent. But we need to go beyond.
So far, the critical factor that has come in the way of growth has been interest rate preferences of the RBI. The finance minister, too, has been urging the RBI to get bi-focal and look at growth, not just inflation. This is what has to be done aggressively to spur investment as the rate of fixed capital formation has been coming down in the last few quarters. This is due to low demand conditions as well as high interest rates. Dr Rajan’s caution on the generation of new non-performing assets (NPAs) can make banks more risk-averse. This can clog the transmission mechanism.
The market is currently wondering about two issues.
The first is: will the governor reverse the measures taken earlier to protect the falling rupee? The steps on the liquidity side have to be rolled back to provide a fillip to banks in particular, especially since the imposition of curbs on the liquidity adjustment facility (LAF), maintenance of cash reserve ratio (CRR), and marginal standing facility (MSF) rate did not quite help. In fact, it raised the cost of funds for banks that were borrowing more in the short-term market. The partial rollback of some of the measures on outward FDI and remittances, on the day that
Dr Rajan took over, has been interpreted as his idea. This should be logically followed up with other measures.
The second is whether the governor would live with higher inflation but work on propelling growth, which is the need of the hour. This would be the strong signal that would be expected to be sent by him which can turn things around. Any such measure will coincide with the upcoming festival period, and there is therefore a hope that there would be a demand- led recovery.
The governor has spoken a lot about creating “confidence”. It is the interpretation of this concept that would steer future discussion.
The market has taken the view that the RBI is obsessed with inflation and would not be averse to sacrificing growth. This view has to change internally. This means that a lot more has to be done by the RBI to move beyond sentiment, which certainly looks much better now but by itself cannot steer the ship. Clearly, the market expects some positive action on September 20, going beyond words.
So far, the critical factor that has come in the way of growth has been interest rate preferences of the RBI. The finance minister, too, has been urging the RBI to get bi-focal and look at growth, not just inflation. This is what has to be done aggressively to spur investment as the rate of fixed capital formation has been coming down in the last few quarters. This is due to low demand conditions as well as high interest rates. Dr Rajan’s caution on the generation of new non-performing assets (NPAs) can make banks more risk-averse. This can clog the transmission mechanism.
The market is currently wondering about two issues.
The first is: will the governor reverse the measures taken earlier to protect the falling rupee? The steps on the liquidity side have to be rolled back to provide a fillip to banks in particular, especially since the imposition of curbs on the liquidity adjustment facility (LAF), maintenance of cash reserve ratio (CRR), and marginal standing facility (MSF) rate did not quite help. In fact, it raised the cost of funds for banks that were borrowing more in the short-term market. The partial rollback of some of the measures on outward FDI and remittances, on the day that
Dr Rajan took over, has been interpreted as his idea. This should be logically followed up with other measures.
The second is whether the governor would live with higher inflation but work on propelling growth, which is the need of the hour. This would be the strong signal that would be expected to be sent by him which can turn things around. Any such measure will coincide with the upcoming festival period, and there is therefore a hope that there would be a demand- led recovery.
The governor has spoken a lot about creating “confidence”. It is the interpretation of this concept that would steer future discussion.
The market has taken the view that the RBI is obsessed with inflation and would not be averse to sacrificing growth. This view has to change internally. This means that a lot more has to be done by the RBI to move beyond sentiment, which certainly looks much better now but by itself cannot steer the ship. Clearly, the market expects some positive action on September 20, going beyond words.
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