In the final tally, it was probably a debate between doing something and holding fire following the recent hike in the cash reserve ratio (CRR). Further, if additional monetary action was warranted in this policy, the choice was essentially between hiking CRR and increasing policy rates. By not letting the rupee go, the central bank has already dropped a loud hint about the option of using the exchange rate to check inflation.
Symbolic step: A steel plant at Hisar, Haryana. RBI raised CRR perhaps to show that it is doing something to curb inflation, which is rising due to higher costs of commodities such as steel, cement and agri products.
The majority of economists expected a hike in the repo rate, and almost no one expected another CRR hike so soon after the last one. True to his form, governor Y.V. Reddy surprised yet again, by keeping the repo rate unchanged but announcing a small — almost a token — CRR hike. Recall that the governor had kept rates unchanged at the January meeting, defying market expectations of a cut at that time. The swing in market expectations of monetary stance in the last three months is probably the greatest and swiftest we have ever experienced.
Perhaps the compulsion of being seen as doing something in the latest policy prompted the governor to announce the near-symbolic CRR hike of 25 basis point. Frankly, he could have got more bang for his buck had he chosen to hike the cumulative 75bp increase in CRR in recent weeks in one go, and announced that at Tuesday’s policy.
The central bank’s full-year growth forecast of 8-8.5% for 2008-09 appears optimistic, as tighter monetary policy for longer than previously thought, along with softening external demand, will pull down growth closer to 7-7.5%. Further, the revision to the inflation forecast for the current fiscal year to 5.5% from last year’s 5% could be misinterpreted to mean that the Reserve Bank of India (RBI) is still favouring an elevated growth target, and is willing to live with higher inflation to achieve that growth outcome. Unfortunately, that is exactly the message that should not go out in the current context.
Relying on CRR gives the central bank more flexibility about liquidity management in case of a reversal in liquidity conditions that would not be possible with hikes in the repo rate, which in any case is already too high relative to US rates. The worsening balance of payments this year is probably a key reason for not letting the rupee go, and it appears poised to weaken further against the dollar in the near-term.
Those peddling rupee appreciation as a quick-fix solution to lower inflation should come up to speed on why countries that have allowed outsized appreciation of their currencies are still experiencing higher inflation that is prompting them to tighten monetary policy.
Investors are still adjusting to the downwardly revised expectations about moderating — but still impressive — growth, and worsening fiscal dynamics.
Further fiscal measures are likely to check inflation that will probably remain elevated for the next few months.
Additionally, more monetary tightening cannot be ruled out, though RBI will likely retain its preference for tightening via hiking CRR rather than policy rates.
Rajeev Malik is executive director at JPMorgan Chase Bank, Singapore.