In choppy waters

India’s monetary policymakers are faced with the task of restoring confidence in the economy and markets, which have been shaken by rising oil prices and the falling rupee. The effects of this cocktail are showing up on the prices front, with core inflation creeping up even as August retail inflation ruled below 4 per cent. According to analysts, the excise duty cut announced on Thursday is expected to translate into a nine basis point reduction in retail inflation. While the cut does not compensate for the increases in excise duty over time, it was long overdue. However, a falling rupee, being pushed downward by inelastic oil imports, can outweigh such moves to negate inflation. Indeed, the view that the rupee should be allowed to find its ‘natural value’ cannot be sustained beyond a point when short-term flows rather than trade fundamentals start to play a key role. The time has come for the central bank to signal that it is in control of the currency and will not brook speculative activity on this count. The situation bears parallels with mid-2013, when the RBI had to step in to shore up the rupee, at a time when oil prices were ruling at over $100 a barrel. In many respects, India was in a worse way then: the fiscal and current account deficits were higher, despite a lower growth rate; and foreign exchange reserves at lower levels. Yet, there is a new factor that has complicated the equation: the collapse of IL&FS. It is likely to further reduce the elbow room for the Monetary Policy Committee (MPC) with respect to containing future inflation. An interest rate hike as well open market sales of bonds, which appear to be an option for their effects on both prices and capital flows, could worsen liquidity conditions in a market already wracked by IL&FS’ serial defaults. The recent relaxation of statutory liquidity requirements to provide succour to borrowers may be negated by any such move.

Instead of raising interest rates, the RBI and the Centre should bring into effect the moves that eventually worked in restoring normalcy in 2013. These include opening a forex swap window for oil companies (they can borrow dollars for rupees and return at a later date) and offering an attractive return on NRI deposits with an element of currency risk too being covered. With the US raising interest rates and capital moving out of emerging economies anyway, it is worth considering whether a rate hike will be effective in checking outflows. Rather, it may interrupt signs of a pick-up in investment and capacity utilisation. A check on banks’ overnight lending could help contain any carry trade in the dollar.

The Centre’s efforts to control non-essential imports have so far spared gold, which may, in fact, be imported in large quantities in anticipation of such a move. Gold imports need to be examined. The MPC and the Centre should consider a range of options to achieve the desired objective.

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