After the RBI’s series of policy measures in recent weeks aimed at stabilising the rupee, ,the market was anticipating no change on Tuesday. As expected, the central bank kept the repo rate and CRR unchanged and also reaffirmed that the stringent measures were temporary.
But this was not enough to assuage the fears of the bond market, which has been hit the most. According to some reports, the sharp rise in yields has left banks with mark-to-market losses of around Rs 60,000 crore. With quarterly profits of only Rs 18,000 crore, the banking system could be staring at a big hole in FY14.
With short-term rates above 11 per cent, corporates are facing the heat of increase in cost of borrowing along with declining profitability, slowing external demand and redemption pressures for repayment of external commercial borrowings that remain largely unhedged.
The drying up of domestic liquidity and increase in market interest rates together mean that growth would be hurt, corporate defaults could rise and the banking system saddled with greater non-performing loans.
Banks have therefore rightly been demanding some immediate relief in the form of hike in the held to maturity (HTM) portfolio from the present 23 per cent. There is also need to inject liquidity into the market.
One way this can happen is when the RBI buys dollars and sells rupees but in the present scenario of dollar drought this is not feasible. Another option is increase in government spending, which could happen with the approaching elections.
Structural reforms needed
Ultimately, to revive investment and get forex flows back, we need structural reforms that will boost investor confidence and give a push to growth. Support to manufacturing, along with increase in competitiveness will help increase exports and reduce the CAD.
Going forward, good monsoon and government’s plans to offload some foodgrain from its stocks could help moderate inflation and boost rural consumption demand.
Emerging markets are seeing a return to stability and we could see capital inflows into India as growth picks up on the back of proposed reform measures, which is a positive for the rupee and the CAD.
Thus, going into the busy season, the RBI may then shift focus back to growth, cut the Repo rate gradually by 50 bps in H2 FY14 along with restoring the marginal standing facility (MSF) corridor. Even a CRR cut of 50 bps in H2 of FY14 to ease liquidity and facilitate monetary policy transmission cannot be ruled out if reforms get the wheels of the economy to start moving…forward.
(The author is an economist.)