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The Reserve Bank of India (RBI) sounded a hawkish tone ahead of the first quarter monetary policy review on Tuesday, as the weak currency is exerting upward pressure on inflation. According to the central bank, its priority will be to restore stability in the currency market.
At the same time, the central bank has shown concern on growth, weakest over a decade in 2012-13, with a slow recovery. RBI had reduced policy rate by 125 bps in the one year till May 2013 to support growth.
At its review, RBI is widely expected to hold the key policy rates as these are, amid a hawkish tone, aimed at halting further depreciation of the currency. The rupee has weakened about 9.5 per cent against the dollar since April, prompting the central bank to squeeze liquidity from the system to make the rupee expensive. “RBI’s measures on July 15 to address exchange rate volatility helped stabilise the rupee subsequently,” it said in its Macroeconomic and Monetary Development report, issued on Monday.
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While bankers were looking forward to any indication on how long the present curbs on liquidity would continue, the central bank provided no indication. “The tone of today’s statement seems that RBI has bought some time to provide measures which will bring some stability to rupee/dollar, which is the focus as of now. In that, breathing space which could be 2-3 months, if measures are taken by the government which will either correct CAD or improve the funding side of CAD then monetary policy focus could shift to other challenges faced by the economy,” said Sandeep Bagla, executive vice president, ICICI Securities Primary Dealership.
“(The) Recent liquidity tightening measures taken to curb volatility in the exchange rate provide, at best, some breathing time. This strategy will succeed if reinforced by structural reforms to reduce the current account deficit (CAD) and step up savings and investment,” RBI said. In 2012-13, the CAD hit a record high at 4.8 per cent of GDP, much higher than the central bank’s comfort zone of 2.5 per cent. RBI, however, said this might show improvement, as gold demand would fall due to the increase in customs duty and rationalisation of the import policy on it. The central bank, at the same time, raised concern over financing the CAD.
It said the most important risk was the US Federal Reserve’s exit from an accommodative monetary policy, which would tighten global liquidity; capital flows might move out from emerging and developing nations, including India.
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RBI, though, acknowledged some reform measures taken by the government had helped in stability of the exchange rate. “The government’s announcement on July 16 proposing to liberalise FDI (foreign direct investment) in single-brand retail, petroleum and natural gas, defence production and some other sectors also improved sentiments and work towards bringing some stability to the rupee,” it said. According to Saugata Bhattacharya, chief economist, Axis Bank there may be a ray of hope in the statement made today and the policy announcement will be less hawkish.
“The hawkish and this was indeed expected. There is just one sentence which might be a ray of hope which says RBI will endeavour to actively manage liquidity to reinforce monetary transmission that is consistent with the growth inflation balance and macro-financial stability. Hopefully the policy will be little more dovish indicating that these liquidity tightening measures taken will be temporary,” Bhattacharya said.
It sounded hawkish on inflation, noting consumer price inflation remained high and the rupee depreciation and upward revision in fuel prices would stoke both wholesale and consumer price inflation.
RBI has also acknowledged there was no indication of an improvement in production activity, which wmeant a slow-paced recovery, that too in the later part of the financial year.
“Recovery in growth may take time and is expected to shape slowly as the year progresses. Moreover, sustainable recovery requires control over consumer price inflation that has continued to hover around double-digits for the past 15 months,” it said.
