Partial rollback of July 15 moves, hikes repo rates
Given that there is little evidence of RBI’s draconian rate hikes of July 15 helping the rupee stabilise—indeed, it only fell after the moves—it comes as a big surprise that RBI Governor Raghuram Rajan has not just refused to fully roll back the interest rate hikes, he has gone on to raise the repo rate, and indicated there could be more in the near future. That the Governor spoke of RBI’s moves to “dampen volatility in the foreign exchange market” is not surprising since he supported the moves when he was chief economic advisor—on Friday, he spoke of the “timing and direction of further actions on exceptional measures” being “contingent upon exchange market stability, and can be two-way”. This is surprising, and it would have been nice if he had dwelled on it more in the press conference since a simple plot of various EM currencies over the past few months makes it clear the rupee’s movement—the sharp collapse and the quick, though not complete, pullback—was not unusual. To the extent, the rupee’s pullback in recent weeks has been sharper than that of some other currencies, this was due to the decision to keep oil companies’ demand out of the market by opening a separate window at RBI for them—this will have only a temporary impact as this lowers India’s forex reserves—and the announcement of the $50 billion Japanese swap, $10 billion of which can be drawn down almost immediately. For the rest, all EM currencies appreciated once it was clear the Syria situation was not going to spiral out of control into a larger war and when the US' weak jobs data suggested the Fed taper would be a mild one—eventually, the data looked weak to even the Fed, and the taper itself has been put off for a few months.
Given this, even if Rajan was worried about inflationary pressures, he needed to roll back the July 15 measures and go ahead with a standard repo hike—the good thing though is that with even the partial rollback, the attempt is to try and bring India’s inverted yield curve back to normal. Though the MSF cut of 75 bps will help banks save R525 crore per year, assuming the daily LAF remains at current levels, and the 25 bps repo hike will raise costs by a much-lesser R75 crore, banks like SBI and HDFC Bank have indicated that there could be a hike in base rates as RBI is very clearly signalling rate tightening. Indeed, while Rajan said the MSF would do more of the walking as it went back to being 100 bps over the repo, his statement eschewed the usual RBI talk of core WPI which continues to fall, to December 2009 levels now. Instead, Rajan spoke of CPI that remains much higher. But since there is 125 bps of the MSF hike to still unwind, Rajan can hike repo rates for another policy or two while appearing to be cutting rates. Like his predecessor, Rajan underscored the government’s role in getting growth on track by talking of the expected diesel hike and clearances by the CCI. He did it more elegantly though, perhaps helped by gushing TV anchors at his press conference who, impressed with his plans to attract forex flows, asked whether he was prepared to be buying dollars when the rupee started to appreciate.