RBI waging a long battle as demonetisation puts spanner in its works

Rupee sank to a record low last week and foreign investors sold a net $2.3 billion of Indian stocks in November—the biggest outflow in more than a year


It has been less than three months since new RBI governor Urijit Patel took charge, critics are already questioning his low-key profile. Photo: Mint
It has been less than three months since new RBI governor Urijit Patel took charge, critics are already questioning his low-key profile. Photo: Mint

Mumbai: India’s new central bank Governor Urjit Patel is facing fires on multiple fronts as he prepares for next week’s monetary policy review.

A cash shortage triggered by Prime Minister Narendra Modi’s decision to void 86% of currency in circulation and an accompanying surge in banking liquidity as Indians deposit their worthless bank notes threatens one of the world’s economic bright spots. Gross domestic product data due later Wednesday is likely to highlight what’s at stake as economists forecast a 7.5 expansion in July through September from a year earlier.

As if that weren’t enough, the rupee sank to a record low last week as the prospect of further interest rate increases by the Federal Reserve sucks money away from emerging markets. Foreign investors sold a net $2.3 billion of Indian stocks in November, the biggest outflow in more than a year. Meantime, less than three months into his tenure, critics are already questioning Patel’s low key profile.

“The policy decisions that are being made are very much on-the-go versus a clearly thought out plan that factors in some contingencies,” said Rajeev Malik, Singapore-based senior economist with CLSA Asia-Pacific Markets. Patel will cut the policy rate on 7 December to cushion the economy, he predicts.

While GDP growth probably quickened from 7.1% in the April-June quarter, a separate survey shows that the pace of expansion will slow to 6.9 % in October-December. The GDP data is due at 5.30 pm.

Modi’s 8 November move to invalidate existing Rs500 and Rs1,000 bank notes “is likely to create a shock to demand in the near term as vendors are unwilling to accept the old notes and buyers are still struggling to acquire the new ones,” Shilan Shah, Singapore-based India economist at Capital Economics Ltd, wrote in a report.

Modi may need until May to replace all the bills, boosting pressure on banks as pay day looms in the cash-based economy—typically arriving in the first week of every month for most employers. Noticing that shop and small business owners are clinging on to valid bank notes fearing shortages, the monetary authority eased withdrawal limits on Monday.

Liquidity surge

However, more than Rs8 trillion have been deposited into banks as Indians look to convert their defunct currency holdings. To mop up the surge, the central bank asked commercial lenders to sequester the deposits as reserves.

The government is also considering raising the amount of bonds it issues to the central bank to use as tools to control liquidity. Once this is permitted, the RBI will review its stance, Patel said in a rare interview on Sunday. His silence on the demonetisation until then had triggered calls for his resignation and questions about the RBI’s autonomy.

“All major policy changes should be explained,” said Jan Dehn, London-based head of research at Ashmore Group Plc, which manages about $55 billion in assets. “Otherwise, the RBI is right to keep communications to a minimum and let market participants make up their minds. That is after all what market participants are paid to do, not to stand paralysed like deer in the headlights.”

Hot tin roof

Investors looking to hold Indian bonds for a long time should take advantage of the current sell-off, according to Killol Pandya, Mumbai-based head of fixed income at Peerless Funds Management Co., which oversees Rs9.7 billion . The yield on 10-year sovereign debt rose on Monday by the most since August 2015, paring this month’s decline to 47 basis points.

The nation’s stocks have also been battered over the past few weeks. The benchmark equity index traded at 15 times projected 12-month earnings on Friday, near the cheapest level since May.

For the coming weeks, though, investors will turn to the authorities for clarity amid heightening volatility in emerging markets.

“It will take some time for the market to get its confidence back,” Pandya said. “It’s like a cat on the hot tin roof.” Bloomberg

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