Policy conundrum at its best

Sep 19 2013, 01:56 IST
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SummaryWhile expectations are building for Rajan to ease monetary policy, domestic macro conditions severely limit the scope for this

As we head into the maiden monetary policy statement of RBI Governor Raghuram Rajan on September 20, expectations have started to build on a reversal from the tight liquidity measures instituted onwards from July 15, 2013, whereby the overnight rate was jacked up by a massive 300 bps. The basis of this is that Rajan, when he was the chief economic advisor at the finance ministry, had talked of the interest rate measures being temporary in nature and hence could be looking forward to reversing these at the earliest opportunity. Corporate India also thinks that it was too much of a sledge-hammer that was used by RBI to contain currency instability as it risks a sharp increase in the NPAs of the banking system and has the potential of pushing down growth further than the current levels.

The key question that is on everybody’s minds now is whether the interest rate measures that were announced to quench the volatility in USD/INR (dollar-rupee exchange rate) have been successful or not. On July 23, when the second round of measures to tighten liquidity was announced, the USD/INR was at 59.77 and fell to 60.49 on July 30, the day RBI announced its mid-quarter monetary policy review. However, thereafter, there has just been an almost unchecked slide in the USD/INR to an all-time low of 68.85. Some semblance of stability has now come back to the domestic currency markets after the OMCs were allowed a special swap window by RBI to source their dollar requirements and after measures taken by Rajan (FCNR(B) deposits to be swapped at a concessional rate with RBI and banks’ allowed overseas borrowing up to 100% of Tier 1 capital) on September 4. Thus, it may appear to be a no-brainer to argue that rather than interest rate measures, addressing avenues that boosted dollar reserves and reduce demand for dollars may have had a bigger influential on the dollar-rupee exchange rate. On the basis of this argument, it is logical that the tight interest rate measures need to be reversed immediately.

However, this issue may not be as simple for RBI as it might appear. The issue pertaining to the efficacy of the interest rate measures will always remain debatable as no one would ever know what could have happened to the USD/INR if such measures were not enacted at that particular point in time. Rajan, post RBI’s monetary

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