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Import revival, dollar strengthening can keep rupee under pressure: Jignesh Shah

While monetary stability clearly remains focus area, as inflation is highly sticky, there is high possibility that once economy starts recovering, the worry of rupee depreciation shall come back

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Jignesh Shah Mumbai
On 01 April, Dr. Raghuram Rajan, RBI Governor will review the Monetary Policy. The street does not expect any major changes in rates. But, there is high probability that he shall provide enough guidance about forthcoming uncertainties in the mid of enhanced tapering of monetary stimulus by Ms. Janet Yellen and also as Indian economy starts with recovery backed by cyclical forces.

While event unfolds in next two days, let’s understand backdrop under which this monetary policy shall be announced. Investments have taken a serious nose dive in the past couple of years after a strong run in the previous decade. This is a key reason for the significant slowdown in India’s GDP growth in recent years. This trend is not unique to India, it has been more pronounced than in many of its peer economies. What has also been noteworthy is that the quality of investments has declined.
 

What explains this? The RBI has been blamed for keeping interests rates high, but at the same time high inflation has also been blamed. Some point to fiscal excess and the lack of structural reforms as key reasons. Looking ahead, the outlook for the investment cycle, therefore, depends importantly on the ability of RBI to get inflation under control, government’s efforts to reduce the fiscal deficit to crowd-in the private sector, and structural reform progress to lift growth expectations. However, much depends on the government’s willingness and ability to move things forward. This, in turn, relies importantly on the election outcome in April-May.

With this backdrop, now let’s try to understand what can Governor do. In fact, recently during Inaugural speech by Dr. Raghuram Rajan, Governor at FIMMDA-PDAI Annual Conference 2014, on February 26, 2014 at Mumbai, Governor highlighted few key points. “As you know, the Reserve Bank for India was constituted “to regulate the issue of Bank notes and the keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage”. Implicit in these words are the core purposes of the RBI: to foster monetary and financial stability conducive to sustainable economic growth, and to ensure the development of an efficient and inclusive financial system.

Note that the RBI is committed to getting the strongest growth possible for India – there is no difference between us and North Block on this. We believe the best way we can foster sustainable growth in the current situation, other than through developing the financial sector, is through monetary stability -- by bringing down inflation over a reasonable period of time. More specifically, we intend to bring CPI inflation down to 8 percent by January 2015 and 6 percent by January 2016.”

For the month of February, while CPI has come down to 8.1% and WPI has come down to 4.68%, the latter is the lowest in nine months. Since, this is backed by low vegetable prices, scepticism still remains about sustainability of such low prices.   
In the same speech Governor pacified the rate hike expectations by acknowledging that “Rather than administer shock therapy to a weak economy, the RBI prefers to dis-inflate over time rather than abruptly, while being prepared to do what is necessary if the economy deviates from the projected inflation path. As of now, we believe the rate is appropriately set.”

While monetary stability clearly remains focus area, as inflation is highly sticky, there is high possibility that once economy starts recovering, the worry of rupee depreciation shall come back on scene. The comfortable BoP position has kept the INR in a safe zone, but import revival and dollar strengthening (potential US recovery) are likely to keep the INR under pressure, for 2HCY14.




(Views expressed are by Jignesh Shah, independent investment advisor. He can be reached on jshah@capitaladvisors.co.in)

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First Published: Mar 31 2014 | 9:26 AM IST

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