Markets awaiting news on reappointment, not repo
In what’s probably a first for monetary policy in India, the stock, bond and currency markets will pay more attention to what signs, if any, RBI GovernorRaghuram Rajan gives on whether he is going to get an extension—certainly, many of the questions in the post-policy press conference tomorrow will be aimed at eliciting this information—and much less to whether he cuts the repo rates or lowers the CRR. Whether Rajan stays or goes, both the finance minister and the prime minister are right in saying, is not something that should be a matter of public debate, but thanks to the allegations made by BJP MP Subramanian Swamy, that is precisely what they have become, so much so that even ratings agency S&P’s chief economist has weighed in favour of an extension to the Governor. While it was perfectly legitimate for Swamy to disagree with Rajan’s choice of the CPI over the WPI in reading inflation—this newspaper has held the same view—both the FM and the PM have wisely refrained from getting into Swamy’s more personal allegations except to say (in the case of the FM) that such personal attacks were undesirable.
Going by the stunning performance of the economy despite two years of back-to-back drought, certainly the headline numbers don’t call for the RBI cutting rates, more so since the monsoon will provide an additional boost to growth, as will the money from the Pay Commission award. But even those who believe the new GDP numbers aren’t kosher will agree there isn’t too much that a repo rate cut can do, apart from the fact that the central bank would in any case like to see whether the Fed raises rates—and what signals it sends for future rate hikes—before taking any action. For one, with RBI cutting rates by 150 bps since it began cutting rates in December 2014, banks have passed on only 70-75 bps by way of a cut in the base rate and maybe another 20 bps if you take into account the new MCLR. Part of the reason for this, of course, is the poor liquidity conditions which RBI promised to fix over a period of time—which is why some are looking at RBI cutting the CRR to infuse more liquidity into the system. More important, with no real demand in the economy for funds, banks would prefer not to pass on the full cut—bank deposit rates have fallen by around 120 bps since RBI started cutting rates—and try and revive their balance sheets by as much as possible since it is by no means certain that the government has enough funds to completely recapitalise them. Meanwhile, though it is likely not extending Rajan’s tenure will see a collapse in the markets, whether this will be more permanent will depend upon whether his replacement will be tough on inflation, as keen to clean up banks and, more important, as innovative—when the rupee looked like it was in free fall at the time Rajan took over, his agreeing to take on part of the currency risk through swaps helped bring in enough forex to help stabilise the rupee.