In devising its monetary policy, the RBI has had to assess the risks of a widening current account deficit (CAD), moderating yet elevated inflation, slowing growth, particularly in infrastructure investments and strained banking asset quality.
Monochromatic tools such as the repo rate or CRR struggle to address these risks simultaneously. Instead, they fuel the perennial growth versus inflation/ FX debate.
Just as other central banks have used innovative responses over the past few months to address their unique issues, perhaps we need other options as well.
Perhaps the common denominator that can satisfy multiple risks simultaneously is focusing on reviving and incentivising infrastructure investments in the country. In the long run, a credible infrastructure story is critical to controlling inflation by removing supply bottlenecks. A credible infrastructure-led domestic growth story can also help channel domestic savings towards growth rather than into the BOP-threatening gold.
Refinance facility
The issue is not just one of solving for government policy alone — though that does account for a bulk of the issues; 15 per cent of bank assets are into infrastructure, and some of them are showing signs of stress. Financial closure for fresh infrastructure projects can be a struggle, and credit, particularly long-tenor credit, is constrained.
Perhaps, the RBI could mull a refinance facility for incremental infrastructure financing by banks, particularly for long-tenor financing. Perhaps it could grant Priority Sector Lending status to such loans.
Such a step could ensure directed financing to infrastructure, as opposed to consumption (and inflation spawning) demand.
In the absence of such a directed solution, lowering the Repo rate and CRR was arguably the next best option. Bond yields could be under a bit of pressure with supply in February, but 10-year yields should move back towards 7.75 per cent in the run-up to the Budget, where the Finance Minister has promised tight control on deficit.
With regard to rupee vs US dollar, current account deficit remains an issue, which is temporarily being addressed by capital flows. With a revival in global growth, particularly in the US private sector, exports should do much better in 2013.
The rupee should remain in a 53.00 to 56.00 range, and move out of this depending on how the infrastructure investment story pans out.
(The author is MD, Global Markets & Regional Co-Head, Wholesale Banking, South Asia, Standard Chartered Bank).