RBI has little choice but to maintain status quo on policy

The Reserve Bank in its latest review of monetary policy decided to keep the repo rate, reverse repo rate and CRR unchanged at 7.25 per cent, 6.25 per cent and 4 per cent, respectively. The other changes introduced on a temporary basis on July 15 to contain rupee volatility were also retained.

Also, the current macroeconomic indicators do not give it room to ease its monetary policy stance.

The RBI is in a Catch-22 situation. It is compelled to maintain the internal and external value of the rupee at any cost, which is becoming difficult in the background of lack of growth, increasing deficits (fiscal as well as current account), declining investor confidence, and falling savings trend.

Also, there is no quick-fix to bring down the persisting high retail inflation caused by rupee depreciation. Inflationary expectations are also high because of the increasing fiscal deficit and the political agenda to implement the food security bill.

Banks are feeling the heat of liquidity constraints. Finding it difficult to raise resources from the Reserve Bank, they are forced to raise interest rates to get deposits. But they don’t have an adequate market to deploy them profitably, and recovery of loans is becoming increasingly difficult.

At this juncture, banks cannot think of reducing the rate on advances. The chances are that they may have to eventually raise it.

Now, what is the FSDC (Financial Stability Development Council) doing? Its very creation undermines RBI’s supremacy over the financial system. And, an element of uncertainty has crept into the equity, bond and forex markets as well.

The quarterly results of companies, except perhaps of those in the IT and pharmaceutical sectors, are not impressive and investors’ confidence in the equity market is on the wane.

The debt market has also been showing symptoms of weakness. The forex market continues to be volatile despite the RBI’s specific measures to contain the rupee fall, which has again breached the Rs 61/$ mark.

Speculation in the currency market seems to have affected the sentiments of both importers and exporters alike, choking the growth in trade, which, in turn, has a negative impact on production, inflation and GDP growth.

Of late, the bullion market has also been fluctuating with an upward bias, indicating more confidence of investors/savers in gold than in any other asset

The external market also does not offer any solace, as raising funds overseas is not exactly cheap but also risky in the context of the unstable rupee. The scope for NRI/sovereign bonds is limited as the funds may not come cheap in the background of weak macroeconomic factors.

The only way to raise inflows is to enhance NRI deposits, by offering additional interest and incentives through CRR relaxations. The prospects of attracting debt inflow look bleak.

This is the time for the FSDC to come to the rescue of the entire financial system, by focussing on the positives of the domestic segment of the economy.

EASE TAXES

One way to to pull the economy out of its present condition is to ease some tax rates and, thereby, attract both savings and investment.

The tax on fixed deposits needs to be completely eliminated to compensate the investors against inflation and, at the same time, prevent them from parking their funds in real estate and gold.

The savings potential needs to be fully tapped to bridge the gap between savings and investment.

The costs, if any, incurred in this regard are worth the salt. Simultaneously, the administrative hurdles inhibiting production and supply, particularly of food products, need to be identified and removed as fast as possible to bring down retail inflation.

The need of the hour is to boost the confidence in the economy and any attempt to raise revenue now will only boomerang.

The RBI’s present concern on rupee stability and its fight to bring down inflation deserve full support from all segments of the economy and, for this, the confidence level in the economy needs a boost through result-oriented measures from the Government.

(The author is a Bangalore-based financial consultant.)

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