Indian monetary policy is beset with problems; the recipes and policy reflexes which used to work in the olden days have become increasingly out of touch with the dynamics of a new India. Right now, the market is confused about what is going on with interest rates, exchange rates and the monetary policy rule. The market is unable to understand how a central bank would follow an inconsistent policy framework.
In this setting, the `credit policy statement' that is coming up on the 31st is unusually important. Many financial market practitioners are anxiously hoping that RBI will come up with plausible answers to the host of questions that are up in the air - questions about capital controls, exchange rate regime and monetary policy. What is monetary policy doing, and what comes next? I'll update this blog entry over the coming ten days, as events unfold.
Pre 31st: The setting
- Not all FII money is hot, an editorial in Economic Times.
- Policy without framework by Ila Patnaik in Indian Express.
- India's victory over inflation may be short-lived by Andy Mukherjee on Bloomberg.
- India's untenable currency policy by Ila Patnaik in Financial Express.
- Ease the peg, an editorial in Financial Express.
- ECBs as villains, an editorial in Financial Express.
- Rating the credit policy, an editorial in Financial Express.
- There is a lot of talk about capital controls against ECBs. Economic Times has a great front page story Curbs go kaput as firms brandish put options by Sugata Ghosh and Rajesh Unnikrishnan about firms doing financial structures which solve the problem of restrictions against debt flows. While on this subject, you might like to see my blog entry titled Synthetic corporate bonds.
31st: What was done
The limit on Rs.3000 crore for reverse repo was removed, and the CRR was bumped up by 50 bps.
However, the most significant development over the last quarter has been the rise in the external value of the rupee. While expectedly not making any commitments on how it proposes to deal with the situation, the RBI has laid out the various pros and cons of the appreciation with respect to its impact on the real economy, and expressed a willingness to use all available instruments to deal with the situation. This seems to indicate that it will eventually return to its pre-April stance of resisting appreciation, with a consequent increase in capital inflows, accumulation of reserves and further pressures on liquidity. This could well become a never-ending battle. If monetary policy is to transit from merely dealing with immediate problems to creating a more enduring framework for high growth and low inflation, this issue must be squarely addressed. The quarterly announcement on Tuesday failed to do that, which is a pity because the problem is not about to go away. Indeed, most forecasts point to a further increase in the rupee’s external value. That’s a headache the RBI will have to deal with, sooner than later.
Financial Express has an edit titled Only halfway there which says:
What might appear to be a judicious mix of policies—some appreciation, some hiking of the CRR, some MSS issues and some interest rate hikes—only takes us deeper and deeper into this problem. What looks perfectly justified in the near term can look profoundly self-defeating in the overall context. Despite the need to confront all these difficult choices with due forthrightness, sadly, the RBI’s credit policy continues to be evasive on the big picture.
Andy Mukherjee notices the inflationary dangers of the present monetary policy framework.