No lifeline

Roiled by a perfect storm of events lately — firming oil, a slip-sliding rupee, hardening global yields and the IL&FS-induced bond market turmoil — the financial markets had been looking to the Reserve Bank of India, in its latest policy review, to mount a rescue operation on multiple fronts to alleviate these pain points. But by sitting tight on policy rates, sticking to its laser focus on inflation and reiterating that it has no role to play in managing the rupee, the RBI has sent out discomfiting signals to market participants that they are expected to fend for themselves. This best explains why a dovish monetary policy review set off a bloodbath in the stock indices and sent the rupee below 74 to a dollar.

Despite the market reaction, the Monetary Policy Committee’s decision not to tinker with rates after two successive hikes is pragmatic on two counts. One, the IL&FS episode has already set off a significant spike in interest rates and sharply tightened credit availability for corporate borrowers in recent weeks. In the circumstances, a hawkish MPC would have aggravated the debt distress for India Inc and markedly worsened the refinancing crisis for NBFCs. Two, on forex flows, it is market interest rates rather than RBI’s repo rates that influence FPI investing decisions. Given that the 115-basis point spike in India’s market interest rates hasn’t deterred an FPI exodus in the last one year, it is very doubtful if a belated hike by the MPC can work wonders. By shifting its stance from neutral to ‘calibrated tightening’, the MPC has in any case signalled further hikes in coming months. But if the MPC’s inaction on rates is justifiable, the RBI’s sanguinity on emerging external risks and the behaviour of the rupee offer cause for worry. Given the potent cocktail of structural factors behind recent rupee weakness — the global withdrawal of quantitative easing, the spike in US treasuries above 3 per cent, trade wars et al , it appears somewhat short-sighted for the RBI to downplay these risks and hold on to its view that the rupee is just finding its natural value. While the RBI has repeated ad nauseum that it is concerned only with unusual volatility and not the direction of the rupee, it hasn’t specified what level of currency volatility will prompt it to act.

Overall, while the MPC may be bound by its legislative mandate to focus only on inflation targeting, the RBI, as the custodian of the country’s forex reserves and the guardian of its financial stability, is the only institution with the wherewithal to initiate proactive steps to safeguard the economy from macro risks. It is one thing for the central bank to project a picture of calm control when there’s turmoil all around. But it’s quite another for it to give the impression that its hands are tied, or that it is taking a blinkered approach to global developments.

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