Dr Rajan plays a bogey with markets…

What a surprise from Dr. Rajan in his first policy. There were so many expectations not from the policy per se but from the person. Well he did say he is not here for FB likes..

Post-Fed breather, most expected that not only will the liquidity measures be eased but signalling of future rate cuts will also be mentioned in the policy.  However, only one of the wishes was granted (eas eof liquidity) and in other there was a complete surprise (higher repo):

  • reduce the marginal standing facility (MSF) rate by 75 basis points from 10.25 per cent to 9.5 per cent with immediate effect;
  • reduce the minimum daily maintenance of the cash reserve ratio (CRR) from 99 per cent of the requirement to 95 per cent effective from the fortnight beginning September 21, 2013, while keeping the CRR unchanged at 4.0 per cent; and  
  • increase the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.25 per cent to 7.5 per cent with immediate effect.

More importantly, a key feature of Dr Subbarao’s policy- forward guidance has been removed from the policy. Well there were both pros and cons of the guidance statement but Dr Subbarao persisted to provide some guidance to markets. People who expected more on this from Dr Rajan who appeared to be a more market driven C-banker, this would have been another surprise.  Though, mid-term policy was followed by a teleconference with media/researchers/analysts which is an interesting change. We will have to see whether this trend will continue and Mid-q reviews will become more like the main policies or remain a mid-q review.

Coming to the policy. I am not too sure of RBI’s stance really.

  • You first tighten liquidity measures to prevent rupee hammering. So you do not touch the repo despite people saying it leads to shift in policy stance.
  • Now you ease liquidity measures believing Rupee has been saved but hike Repo rate. At the same time the new governor says this is to ease cost of credit to corporates. I mean SBI.HDFC Bank etc have hiked rates already and more to follow post repo rate hike. How will Repo rate hike lead to lower costs of credit?
  • Repo rate hike is not like liquidity measures which could be short-termish. It indicates a more medium term outlook and change in policy stance. So does this mean that we are looking at a tight policy scenario now for some time going ahead? If that is the case, RBI should have written more on its inflation outlook and give its inflation outlook. Yes, it is mid q review and RBI keeps it short. But this is not a usual mid-given q review and with so much being done, inflation outlook could clearly have been as well.I would imagine over a period Dr Rajan will shift base to CPI but this should be backed by words. Otherwise focus will remain on WPI and confusions will remain as the difference persists..
  • So Repo rate hike will only be done if RBI expects inflation to go up from hereon. You are unlikely to do it for just one time.

Can of worms really. Markets have given a thumbs down to the policy. Whatever you do, things go for a toss.

Overall,  a confused sort of policy as it has been the case earlier as well.  In a way, RBI is juggling with this idea of liquidity tools vs monetary tools for a while. Earlier the scapegoat was CRR, now it is a combination of MSF,  Bank CRR management and Repo. How do you intend to ease the liquidity and hike the repo at the same time? Can these two be different?

But yes the intent to target inflation is right. With CPI at 9-10%, RBI remains sensitive to a measure which most do not care about.

Earlier, RBI just did these liquidity tools but did not touch the Repo. Now it is the opposite.  But yields have reacted in a similar manner. But this time the currency may limit the rise in yields.

Fed has clearly given India and Asia another lifeline. But for how long? As Dr Rajan rightly says, this QE tapering is just a postponement.  In the meantime, we need to prepare a bullet-proof national balance sheet. But all this will obviously take time and one does not know what will happen around the elections..

I mean these are lessons for markets as well who make big hue and cry over appointments of rockstar economists (if I may use the phrase). At the end of the day, these econs are most likely going to do as per the mandate of the institution (hopefully). I mean it is getting crazier by the day. Markets reacted crazily when Prof. Summers withdrew his nomination from Fed Chair. The belief was that dovish policies are likely to continue under the next likely candidate Dr Yellen. Well, it is likely that Dr Summers could have been more dovish given his views on state of economy…

And in case of RBI it is inflation first and others come later.

Meanwhile. our hon’ble FM PC continues to take the growth path all by himself..


One Response to “Dr Rajan plays a bogey with markets…”

  1. unconventionaleconomist Says:

    Good blogpost! But I see the mid-q policy review as follows (correct me if I’m wrong). (a) The RBI wanted to loosen liquidity tightening measures, and this was made possible because of the rising INR. This also covers the “putting our house in order” stance. (b) Still, inflation figures (whichever one) are not comfortable, and the RBI signals that this calls for a rate hike. The markets have done well to interpret that there could be more future rate hikes as well, because of the persistently rising inflation data.

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