The Reserve Bank of India’s (RBI’s) monetary policy meet this Friday will give a first glimpse of the Governor Rajan’s approach to tackling India’s growth-inflation dynamics and external vulnerabilities.
So far, his priority of stabilising the currency, as stated on September 4, seems to have been effective as both local and global developments have supported the Indian rupee (INR) recently, said Standard Chartered's Global Research.
The market is also keenly awaiting his statement in order to assess the framework in which monetary policy will be formulated. In this context, his strong emphasis on monetary stability – “to sustain confidence in the value of the country’s money” – will weigh on the market.
In Stanchart's view, monetary stability encompasses the twin objectives of containing inflation and arresting the slide in the INR. Despite the recent INR correction, Governor Rajan’s task will not be easy: he has been in office for only two weeks, market expectations are unreasonably high, a key FOMC meeting takes place on 17-18 September, and WPI inflation ticked up in August.
Market expectations range from a partial reversal of liquidity-tightening measures at one extreme to a repo rate hike to contain inflation risks at the other. Specifically, the market will be watching closely for any announcement of a timeline or preconditions that could lead to a reversal of the liquidity-tightening measures initiated in July. Further, Stanchart views that the recent rupee correction means further measures to stabilise the currency are likely to be deferred. Instead, the governor might reiterate that measures announced on September 4 have succeeded in anchoring exchange-rate expectations, and that US dollar inflows in the next few months should ensure smooth funding of a narrower current account deficit.
A complete reversal of liquidity-tightening measures on 20 September looks unlikely to us. While the rupee’s 7.6 per cent appreciation from 3-16 September is encouraging, the RBI might prefer to wait longer for confirmation of sustained currency stability – a factor that has been emphasised as a key determinant of such a reversal.
However, in order to reassure the market that these measures are temporary, the RBI might recalibrate some of its announcements. For example, it could reduce the daily minimum cash reserve ratio (CRR) balance from 99 per cent, or marginally increase the liquidity adjustment facility (LAF) borrowing limit from 0.5 per cent of net demand and time liabilities (NDTLs). These changes are unlikely to reduce the call rate substantially below the marginal standing facility (MSF) rate (currently 10.25 percent); but we believe they would offer some comfort to the markets, with the hope of further easing later.
"We expect the governor to sound a hawkish note on inflation. August CPI inflation remained elevated and the spike in WPI inflation to 6.1 per cent raised concern about the future inflation trajectory. While the August WPI price pressures arose mostly from a temporary spike in vegetable prices, which we expect to wane in the next few months, the headline number is likely to keep the RBI cautious. Pass-through of higher import costs is not yet complete, and a one-off diesel price increase is still expected. We maintain that the pricing power of industrial products is extremely low – as evidenced in the 2 per cent core inflation print – but Governor Rajan is unlikely to focus on this. Markets will also be looking for an indication of his preferred gauge of inflation. They may respond negatively if the RBI’s concerns about high CPI inflation lead to expectations that CPI inflation will become the new nominal anchor." In his statement on September 4, Rajan highlighted containing inflationary pressures as a priority. This is in line with his view of a monetary policy framework focused on a single objective, namely price stability or low and stable inflation.