Playing safe

Reserve Bank governor Raghuram Rajan has sprung as much of a surprise with a hawkish stance in his maiden mid-quarter monetary policy review as the US Federal Reserve did with its decision to postpone the tapering of the quantitative easing programme.

There were expectations, especially in the light of the benign impact of the US decision, that the RBI would go in for an interest rate cut or at least a status quo. But the apex bank has actually raised the rate by 25 basis points, though it has rolled back some restrictive measures it had implemented some weeks ago to protect a then depreciating rupee. Even the government had indirectly suggested to the RBI that it looked forward to a policy which would incentivise economic growth.  The hike in repo rate will in fact partially negate the impact the rollback measures.

Rajan has, as his predecessor D Subbarao, clearly indicated that the RBI’s priority is containing inflation which has gone up to a six-month high of 6.1 per cent in August. He has said that the inflationary consequences of the depreciated rupee might offset the gains from an expected good harvest and would like to wait for the price situation to stabilise. Perhaps it was also felt that a monetary easing now would have a negative effect on foreign investment flows. Therefore the tight liquidity conditions are likely to continue till there is improvement in the current account deficit position and the rupee stabilises. That again, like in the past, throws the ball into the government’s court. The Fed decision had strengthened the rupee and the markets but the RBI rightly feels that domestic policies are more important than external props. 

The Fed decision gives an extended opportunity to India to take actions which will promote investment and spur growth, contain inflation, reduce CAD and fiscal deficits and to further strengthen the rupee. The winding down of the stimulus programme in the US has only been postponed and it might start happening when the Fed feels that economic recovery is real and stable, perhaps as early as in December this year. If India’s economic indicators show reliable signs of improvement by then, the country will be less vulnerable to the negative consequences of the tapering  of quantitative easing. The RBI also must have felt that a softening of its monetary policy now would have made it much more difficult for it to respond to the Fed action later.

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