Don’t be surprised if Reserve Bank of India (RBI) governor Raghuram Rajan kicks off the process of unwinding of some of the July measures on Friday at the central bank’s mid-quarter review of monetary policy. The US Federal Reserve deciding to hold off tapering of the stimulus for the time being gives him the leeway to do that.
Rajan had postponed the date of the policy review by a couple of days to be able to take stock of the Fed’s decision before formulating India’s monetary policy.
The July measures aimed at tightening liquidity and making short-term rates dearer to protect the local currency. Indeed, the rupee has stabilized, and the Fed’s decision will ensure that the currency stabilization is here to stay as emerging markets, including India, are unlikely to see any flight of capital.
Among others measures, in July, RBI restricted banks’ access to its repo window where money is available at 7.25%, forcing them to access its special window, or the so-called marginal standing facility (MSF), at 10.25%. RBI, in fact, raised the MSF rate by 2 percentage points. Besides, it also took away the flexibility in regard to banks’ maintenance of cash reserve ratio (CRR), or the portion of deposits that banks need to keep with the central bank. Following the July measures, banks are now required to keep 99% of CRR with RBI at any given point in time. Following these measures, market rates of all short-term instruments have risen.
With the US Fed deciding not to rush the tapering of its bond-buying programme now, Rajan is likely to be encouraged to pare the short-term rates. It could be done by bringing down the MSF rate by a percentage point to 9.25%, relaxing the CRR maintenance norms, and even partially lifting the cap on banks’ access to its repo window.
The rupee gained against the dollar, bond prices rose and yield dropped even as all bank stocks soared in Thursday’s opening, expecting the beginning of the reversal of July measures. Will Rajan reverse all the measures and go back to the pre-July level? That is highly unlikely.
After all, the foreign exchange market is still not at its normal self with dollar demand being artificially suppressed by meeting the greenback requirement of oil marketing companies outside the market, directly by RBI. Only if the stability continues, even after the Indian central bank closes the special window for the oil marketing companies, can RBI complete the unwinding process. By that time, it will also get a sense of the flow of non-resident Indian deposits, for which it has opened a special swap window till 30 November.
Rajan is also unlikely to tinker with the repurchase rate for now because of high retail inflation and rising wholesale inflation.
Whether he kicks off the unwinding of July measures or not, the Fed’s decision will give him great comfort while he announces his first policy. His predecessor D. Subbarao was singularly unlucky. He started his tenure roughly a week before the collapse of US investment bank Lehman Brothers Holdings Inc. that plunged the world into an unprecedented credit crunch and ended under the threat of a tapering. Rajan seems to have luck on his side.