Central bank brings growth back on the table
Given the central bank’s moves to defend the rupee have backfired badly in the last month and a few days, RBI has done well to signal a less hawkish stance, even a gradual rollback to status quo ante. Along with two rating agencies affirming their existing outlook, dismissing fears that the collapsing rupee would affect economic growth, this should provide some calm to the rupee in the days ahead. While it is early days yet, FIIs buying up limits of $10 billion available to them in gilts suggests they are looking at coming back to invest—buying up limits doesn’t necessarily mean FIIs will invest since the costs of buying limits are small, actual investments will depend on the FII reading of when the rupee looks more stable. Not surprisingly, given how RBI had gone all out to suck liquidity to prevent the rupee’s collapse, the less hawkish tone coincided with the Governor-designate joining duties a fortnight before formally taking over—FE had suggested yesterday that the best time for RBI to signal a retreat would be when the new Governor took over even though, as chief economic advisor, he had said the finance ministry and RBI were on the same page as far as the rupee-saving measures were concerned. Raghuram Rajan’s new measures not just lay out a path for RBI formally withdrawing its liquidity-tightening, it also addresses the big concerns of a likely R50,000 crore mark-to-market loss for the banking sector as well as rising NPAs as a result of the 200-300 bps tightening of interest rates across different tenure.
While RBI’s July 15 circular described the dramatic hike in the marginal standing facility as necessary to “restore stability to the foreign exchange market” and the July 23 one spoke of the need to address volatility, Tuesday’s circular announced RBI had substantially achieved its objective of raising short-term interest rates, that it was important to ensure this did “not harden longer term yields sharply and adversely impact the flow of credit to the productive sectors of the economy”. To ensure long-term yields fall after having risen 137 bps since July 15, RBI announced its own Operation Twist—R8,000 crore of open market operations on August 23, with future such operations to be calibrated “as may be warranted by the evolving market conditions”. More immediately, given the R50,000 crore mark-to-market losses banks were looking at in the September quarter as a result of the sharp hike in bond yields, RBI announced relaxations in the hold-to-maturity (HTM) portfolios that do not have to be marked-to-market. It will be a while before RBI starts infusing liquidity in the short-end of the market—it may not even have to given the rise in government spending has to pick up as elections draw near—but the move is a sensible one given there is little evidence to show the interest-rate defence has worked well in other countries over more than a very short period of time. While lower interest rates may not necessarily boost growth, indeed repo rates may need to be hiked if US yields keep rising over the next few months, the last thing the markets needed was the shock treatment RBI meted out.