Digging in

RBI’s dovishness in sheltering the rupee from the dogs of demand by keeping repo rate and cash reserve ratio unchanged on Tuesday has achieved the opposite effect. A further rate cut was not expected by the market or even by the ever optimistic P Chidambaram considering that RBI’s monitions on high inflation and balance of payments impacting capital flows, unsteady crude oil prices, current account deficit gap and GDP growth have not yielded outcome-based plans from the government. Moreover, RBI was not expected to effect a rate cut till at least six months into the current financial year. And, not the least when successive rounds of rate cuts have not led to stronger credit pick-up on the ground.

That said, RBI’s priorities to check rupee depreciation are visible through a string of proactive monetary tightening measures down the past week which are still playing out in the market. RBI is understandably perched on a wildly swinging tightrope, counter-balancing a sliding rupee against upwardly sloping inflation. While tightening rupee flows is necessary, RBI has to address risks to macroeconomic stability and address growth concerns by containing inflationary pressures and ensuring adequate credit flow to productive sectors. But while hardening its monetary stance, Mint Street will face the prospect of even more cash-strapped industries which rely heavily on interest cuts, like real estate, construction and infrastructure.

Lowering the repo rate by at least 25 basis points and the CRR (currently at a record low of 4 per cent) by upto 15 basis points in the next policy review in September would make sense from an industry perspective, but reaching a truly high liquidity situation will require the rupee to stabilise to below 55 levels against the dollar. Merely tweaking interest rates in the next monetary policy review could risk even slower economic growth than RBI now prognosticates -- on Tuesday, RBI lowered economic growth projections for 2013-14 to 5.5 per cent from 5.7 projected in May this year.

Applying further squeezes on rupee availability to importers will not help much going forward, as India’s growing trade imbalance or external deficit will undermine any value gains accrued from policy action. The bank should now insist on concrete firefighting plans from the government on how it will lower the current account deficit (CAD) from 4.8 per cent to the bank’s comfort levels of 2.5 per cent.