Collateral damage

By making borrowings from it more difficult and expensive, the Reserve Bank of India (RBI) has done just what most central banks would do to stem a free fall in the local currency: Squeeze its supply to restrict the purchase of other currencies. Until now, banks could borrow overnight ‘repo’ funds from the RBI at 7.25 per cent against their government security holdings in excess of the statutory minimum requirement. Over and above this, they could also borrow from the central bank’s ‘marginal standing facility’ (MSF) window at 8.25 per cent. The RBI has not raised the repo rate, but limited daily average borrowings under it to about Rs 75,000 crore, as against a normal daily average of around Rs 100,000 crore. Any extra money from the RBI can only be availed from its MSF facility, but which will henceforth cost 10.25 per cent.

In effect, what the RBI has done – and without resort to the usual stratagems of raising the repo rate or the cash reserve requirements for banks – is to increase the cost of borrowings from it; this will automatically get transmitted to the broader money/loan market. These measures, along with open market sale of securities held by it (for which an auction for Rs 12,000 crore has already been announced), will make domestic liquidity both tighter and costlier. To that extent, it also becomes more difficult for speculators to borrow in rupees to accumulate dollars and ‘short’ the former.

But the problem here, just as with the tightening of currency derivative norms by SEBI last week, is the huge collateral damage they will inflict on genuine economic activity. Coming at a time when industrial growth is in negative territory and fresh investments aren’t happening, a liquidity squeeze would only exacerbate the current slowdown. It may help rein in those taking one-sided bets against the rupee, but only temporarily. India has, till recently, been attracting copious foreign capital flows that have financed its current account deficit as well as ensured the rupee’s reasonable stability. But these inflows, over $ 89 billion in 2012-13, had been coming in only on expectations that India would grow faster than other economies. The RBI’s renewed monetary tightening — aimed at arresting the fall in the rupee’s external rather than its internal purchasing value — risks killing growth altogether, thereby impacting capital flows and the exchange rate itself. The latest measures, therefore, can be justified at best as a short-term response to avert a speculative attack on the rupee, despite the lack of evidence of that. The rupee’s weakness has more to do with fundamentals, especially slowing growth. This is reason enough to return to pro-growth policies sooner than later.

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