A status quo policy for stability

On the basis of an assessment of the current and evolving macroeconomic situation, the Reserve Bank of India has decided to:

keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.5 per cent;

keep the cash reserve ratio (CRR) of scheduled banks unchanged at 4.0 per cent of net demand and time liabilities (NDTL);

and continue to provide liquidity as required but progressively lower the average ex ante liquidity deficit in the system from 1 per cent of NDTL to a position closer to neutrality.

Consequently, the reverse repo rate under the LAF will remain unchanged at 6.0 per cent, and the marginal standing facility (MSF) rate and the Bank Rate at 7.0 per cent.

In the recent policy statements no mention has been made of the Statutory Liquidity Ratio (SLR), which obviously is not changed. One does not understand the reason for the silence on SLR.

The RBI’s stance on the policy is justified on the basis of the current economic environment, both national and international. It does not want to upset the applecart by making any changes in policy rates and ratios. The trends in growth are satisfactory despite the declining exports. However, the fall in imports has helped keep the current account deficit (CAD) under control.

The only matter for concern is the uptick in inflation rate in April. The RBI expects this trend to continue. So there is no case for any reduction in policy rates. The central bank has noted that while public investment levels are satisfactory those of private investment are not. Are they due to the levels of borrowing rates being high?

In a situation of inflation the depositor or the saver is generally the one who bears the brunt since he does not have any lobby to work for him to get a reasonable real rate of return.

The RBI is right in emphasising the unfavourable trend in consumer inflation in respect of food products. Mumbai may not be the right benchmark for assessing the situation in the country because of its high levels of income and large circulation of money and floating population. But it is worth noting that a single banana costs ₹5 in the city whereas one remembers the days when one could get a dozen at that price!

Prices in restaurants (even in Grade III establishments) have gone up, affecting the middle-class workers depending on them for their needs. We are at the peak of a long, hot summer. Any relief on the food front can be expected only after the kharif harvest, which is still 10 weeks away. The Consumer Price Index (CPI) for the summer months is not likely to provide any satisfaction.

Thus the RBI is right in basing its policy on the current trends in consumer prices. In any case we have to wait for the review of the marginal cost lending rate system before taking any view on RBI policy rates and its impact on investment demand in the private sector.

My view is that despite growth, demand has not picked up due to the persistence of a high level of prices across almost all commodities. A 5 per cent inflation rate is no consolation to a consumer when he goes to the market to buy consumer goods such as shoes that cost ₹2000 a pair.

The Government should consider fiscal measures that encourage R&D efforts contributing to a reduction in costs of production. According to the RBI, “demand conditions are likely to improve going forward; consumer confidence is seen as rising on improving expectations of employment and spending, with rural demand aided by a stronger monsoon. Rising capacity utilisation should prompt private investment”.

There is no shortage of liquidity in the market thanks to the intervention of the central bank. The average daily net liquidity injection through the liquidity adjustment facility (including MSF) declined from ₹1935 billion in March 2016 to ₹1030 billion during April-May and further to ₹120 billion in June (up to June 5, 2016).

The weighted average call money rate (WACR) remained closely anchored to the policy rate within a narrower corridor of plus or minus 50 basis points around the policy repo rate. Volatility also declined significantly. Interest rates on money market instruments such as certificates of deposit (CDs) and commercial paper (CPs) also eased through the quarter so far. Thus there is stability in the markets.

The central bank is generally coy in making any statement about exchange markets lest it disturb them. It only used to say that it had no preconceived idea of the right exchange rate and its only aim had been to prevent volatility in the markets.

In a departure from the usual practice, Governor Raghuram Rajan made a bold statement on the intervention by the RBI to deal with not only rupee shortage but also of the dollar.

This assurance should help arrest the slide in the value of the rupee and prevent its crossing the level of ₹70 to a dollar.

The RBI’s bold statement is credible in view of the substantial forex reserves amounting to $360 billion on May 27, 2016.

The writer is a Mumbai-based economic consultant

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