RBI Policy – A missed opportunity plus some tentative action

The RBI policy announced in June showed a cautious “wait and watch” mode. However, the real need of the hour was to give credibility to the rupee value. That was missing in the monetary policy statement and in policy action.

Another routine policy announcement

To sum up, it was another routine policy announcement. The recent fall in the rupee from ₹90/$ to ₹96/$ happened in just 13 months. That was the sharpest fall in the rupee in the last 10 years. That is not normal and abnormal times call for decisive action. From that perspective, a routine policy was rather disappointing. The RBI MPC chose to hold rates at 5.25% and also held the stance of the policy at Neutral. One would have hoped that the stance would be made to appear more hawkish. Inflation was raised and GDP estimates were cut, but that was known. The question is; what is the policy stance now?

Markets were expecting more action from the RBI

The RBI had its sound reasons for the status quo. If high inflation was making a case for a rate hike, then weak nominal GDP growth needed low rates to sustain consumption. That was surely a dilemma. What markets were expecting was decisive action. A 25-bps rate hike would not have impacted the GDP growth in any serious way. However, it would have sent a clear signal that the RBI was serious about managing inflation and also about managing inflation expectations. More importantly, higher rates would have stemmed capital outflows and even contributed towards hardening the rupee. But the RBI did announce some specific measures to encourage FPI inflows.

Will the measures really pull FPI flows into India?

The RBI MPC announced a specific set of measures to boost capital flows into India. The tax on interest on G-Secs and LTCG on bonds was abolished for FPIs. However, the big question is whether the FPIs would be interested in Indian bonds when the yield spread is less than 200 bps over the US 10-year benchmark? The measures pertaining to FCNR (B) deposits has the potential to pull NRI money, since the forex cover is being borne by the RBI. However, it is very important how the RBI manages its dollar risk, otherwise it may be left with a huge open liability like in the case of sovereign gold bonds. The downside risk is that global bondholders may use this opportunity to book out and exit Indian bonds.

Time for shock value, not bits and pieces

One of the big lessons we learnt in 2013 was that when the currency is in crisis, the need of the hour is shock treatment. Incremental measures will not work. Unlike in 2013, the Indian economy is not among “Fragile Five.” From that standpoint, the RBI had a bigger opportunity to use its macroeconomic clout to defend the rupee. At the bare minimum, it could have sent a signal by raising rates. Also, the hedged inflow measures did not have to wait for the monetary policy and could have been announced long back. When it comes to managing the currency, delays can be expensive and indecision can be very expensive. RBI will have to certainly keep that in mind!