When it comes to returning goodwill for faith reposed, what better way than to return with interest (rates)? And, timely subjugation of inflation rhetoric?
RBI Governor Raghuram Rajan has in his June edition of monetary policy kept interest rates on hold at a steady 8 per cent for the second time in a row. The bank’s inflationary expectations are now clearly anchored on political stability. Rajan has loosened credit by increasing overseas remittances limits from $75,000 to $125,000, which will facilitate Indians to acquire and hold shares, debt instruments and other assets outside India without prior approval from the RBI. He has also allowed foreign investors to participate in domestic exchange-traded currency derivatives. Rajan’s decision to not aggressively deploy the wide latitude the apex bank enjoys in setting monetary policy, will be welcomed by a new government all set to work the nuts and bolts of a tenuous economy.
The decision to hold interest rates will also push the onus onto the Modi government to further contain the fiscal and current account deficits through conservative fiscal spending. Rajan has made it clear that further policy tightening will not be warranted if the economy stays its course. However, this will require the government to narrow the twin deficits further to restore investor confidence, comprehensive policy action to revive aggregate demand, and tackling the supply-side factors impacting food inflation. Money markets will be crucial in ensuring cash for the banking sector to divert to sectors which need them, and RBI has done well to recognise that. RBI has also moved to reduce liquidity provided to exporters as recommended by the Urjit Patel Committee, while pledging to provide additional cash via term repos for loan transactions, which are welcome moves in a largely low credit situation for industries, despite the surging stock market.
The decision to reduce Statutory Liquidity Ratio by 50 basis points might incentivise the government to borrow more at the short end. This may not impact interest rates immediately as banks are already holding excess SLR to the tune of 4 per cent. The bond market, however, stands to gain in the medium term. As for broader reforms, a few ‘legacies of the previous government,’ to quote a now favourite catchphrase of finance minister Arun Jaitley, like the Land Acquisition Act and indecisiveness on opening up FDI in the retail sector, which have drawn catcalls from industry and overseas investors alike, must now be addressed in all urgency.