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On the other hand, the tight liquidity and elevated money market rate curve in the shorter end, as a strategy to address the rupee’s exchange rate (and current account deficit), has not yielded desired results. Considering all these, the best fit is for the Reserve Bank of India (RBI) to take a balanced approach between growth & inflation and rupee & liquidity, while putting pressure on the government to remove supply-side bottlenecks and policy irritants, to revive consumption and investment.
The stake holder’s confidence is weak, given the pipeline political risks from the ensuing elections. The new RBI governor has begun the task well, bringing some kind of relief in the near term. Now, what the system needs is follow-on measures (and actions) to set up a firm launch pad for a strong recovery in GDP growth momentum to touch the FY14 Budget estimate of 6-6.5 per cent. This is the one-point factor to get the economy (and markets) into bullish momentum.
The recent IIP (Index of Industrial Production) print signals formation of turnaround signals in growth, while the inflation data print provides little comfort on a sustainable reversal, with pipeline pressure from fuel and primary articles. The expectation from RBI is to stay focused on growth (as the most major risk to the economy), while not diluting its efforts to control inflation and manage the current account deficit (and the rupee’s exchange rate).
The new governor is expected to retain the pause on policy rates and statutory liquidity ratio/cash reserve ratio, but consider loosening its firm grip on liquidity and interest rates. There is an immediate need to shift the operating policy rate from the marginal standing facility into the liquidity adjustment facility (LAF) — if not in full, then with a higher percentage at LAF, so as to drive the call money rate from more than 10 per cent to 7.25-8.75 per cent on higher liquidity support at LAF.
The highly skewed (and inverted) money market rate curve needs to be reversed, which would be bullish on rate and equity markets; the resultant marginal pressure on the rupee may be acceptable if it leads to 62-65 consolidation.
The author is executive director of Lakshmi Vilas Bank. Views expressed are personal
