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The Reserve Bank of India’s (RBI’s) monetary policy meeting on 20 September, helmed by new Governor Raghuram Rajan, will provide a first glimpse of his approach to tackling India’s growth-inflation dynamics and external vulnerabilities. Raghuram Rajan's priority of stabilising the Indian rupee, as stated on 4 September, seems to have been effective so far; both local and global developments have supported the Indian rupee recently. The market is also keenly awaiting his statement in order to assess the framework in which monetary policy will be formulated. In this context, Raghuram Rajan's strong emphasis on monetary stability – “to sustain confidence in the value of the country’s money” – will weigh on the market. In our view, monetary stability encompasses the twin objectives of containing inflation and arresting the slide in the Indian rupee (INR).
Despite the recent Indian rupee correction, Raghuram 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.
In our view, the recent Indian rupee correction means further measures to stabilise the currency are likely to be deferred. Instead, the Raghuram Rajan might reiterate that measures announced on 4 September have succeeded in anchoring exchange-rate expectations, and that US dollar (USD) 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 Indian rupee's 7.6% 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 Raghuram Rajan might recalibrate some of its announcements. For example, it could reduce the daily minimum cash reserve ratio (CRR) balance from 99%, or marginally increase the liquidity adjustment facility (LAF) borrowing limit from 0.5% of net demand and time liabilities