The Reserve Bank of India (RBI) seems to have changed tactics in the conduct of its monetary policy. There is a distinct shift in focus that is quite evident if one analyses the events of the last week or so.
Let’s recall what’s happened in this time
- The Indian rupee (INR) hit a 9 year high (breaching 40.50 to the US dollar on Tuesday) only to retrace sharply to close at 40.85 on Wednesday.
- Overnight money rates (in the collateralized segment) hit new lows with several deals being struck at 0.10% p.a. levels (Reminds me of Japanese interest rates)
- Overnight money rates have fallen sharply on the back of a liquidity infusion of INR 200 bn on account of the maturity of a government bond. In spite of being aware of this, the RBI opted not to conduct an open market sale of security under the market stabilization scheme (MSS).
To most marketmen, the fact that RBI would take measures to sterilize the large liquidity infusion was an almost foregone conclusion. The absence of an MSS issuance meant that the marketplace is now contemplating a hike in the Cash Reserve Ratio (CRR).
In my view, however, an immediate hike in the CRR is probably unnecessary, clearly unjustified and unlikely to be resorted to in the near future. We should remember that CRR is a blunt instrument which has a systemwide impact in equal measure. It does not differentiate between the big and small, the liquidity surplus or liquidity deficit entities. Further it pays no return whatsoever on the impounded cash, and thus has an adverse impact on banks’ finances.
Why, then, has the central bank allowed the surfeit of liquidity to continue and allowed overnight rates to hug near zero levels. The answer probably lies in the shifting focus of the monetary authority.
While liquidity and interest rate management had received priority in recent times (ostensibly to rein in runaway inflationary expectations), it appears that the focus has now tilted appreciably towards exchange rate management.
By allowing the surfeit of rupee funds to perpetuate in the system, the central bank has eased the pressure on the appreciating rupee, thus partly achieving its objective of managing exchange rate to promote export competitiveness. The voices from the export community had become shriller almost every day, and the central bank seems to have decided to listen to them.
This also signifies that the RBI in general and the Governor Mr. Reddy in particular seem to believe that inflation (or at least that part of inflation that monetary policy can influence) is not so much of a concern now. Some of Mr. Reddy’s recent comments seem to echo this view in a way. He has been making soothing noises on the inflation front - about how inflation volatility is coming down et al.
While it is clear that RBI has changed tactics, what interests me most is to see how long would they persist with this. It wouldn’t surprise me a bit if they change focus again within the next few weeks or even days. Hasn’t that been the hallmark of the conduct of monetary policy in the last few months?
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