In a discussion on RBI's recent measures to stem the volatility in the rupee, a panel of experts were of the opinion that the structural and fundamental issues in the economy need to be addressed first. In the process, growth may also take a hit in the near-term.
The volatility in the rupee can only be addressed if the structural problems in the economy are solved, says former RBI governor and current director of research at Brookings Institute, Subir Gokarn. He believes that RBI's measures to arrest rupee fall will work only if there is a parallel plan in place to solve the structural issues such as the high current account deficit.
"If we don’t have a simultaneous movement on structural issues; steps that are actually addressing the causes of the problem, will peter out over a period of time," said Gokarn in an interview to CNBC-TV18’s Latha Venkatesh.
Agrees Arvind Subramanian, senior fellow at the Peterson Institute of International Economics that much stronger actions from the RBI and government is needed to address issues that the economy is currently facing.
In a string of measures to tighten the liquidity and bring stability in the rupee, the Reserve Bank of India (RBI) on July 15 announced that it will not allow overnight lending of more than 1 percent of the total deposits (Rs 75,000 crore) in its daily repo window. The additional money will be lent at the marginal standing facility (MSF) at 10.25 percent. It also decided to sell bonds in the open market to drain Rs 12,000 crore.
As a result, bonds fell by about Rs 5 and the dollar rupee fell by 75 paise at the maximum to 59.20. The Treasury bill auction and the bond sales were allowed to be a flop. It raised eyebrows in the market whether the central bank was really resolved to address the problem or was it worried about the collateral damage on the economy.
Below is the edited transcript of their interview to CNBC-TV18.
Q: What is your sense? Is the market now of the view that the RBI does not want to push rates too hard, pay too higher price in terms of economic growth to save the rupee? Or is it going with the view that the steps have been only temporarily rolled back so that the RBI would take even rate rising steps to ensure that the rupee gets a floor?
Dave: There is a fairly sizable reaction in the fixed income markets and the potential for them to create another source of problem. You are trying to address instability in the foreign exchange (FX) markets and are trying to anchor expectations there. But, in the process, you are anchoring rate or yield expectations, when the economy, clearly, cannot be ready for those kind of situations.
It is those thoughts which appear to have reflected in RBI choosing that they want to focus only on the FX market. It is those measures which think they have accordingly tried to help the market with.
Q: What would you expect the RBI to do in its follow through? Purely expectation, not what you want the RBI to do. Since they don’t want to disturb yields too much, would a cash reserve ratio (CRR) hike be the logical conclusion. What are you going with as a market man?
Dave: The last four days tell you that the assumed link between interest rate and liquidity domestic and exchange rate level is perhaps not as strong as it might have been believed while taking these measures. Most market participants will tell you that there is very little onshore speculation which is taking place. Banks are, in any case, controlled by the RBI and the positions are quite micro managed and micro known.
Positions taken through the currency futures market both by banks and by non-banks had been taken care of to certain measures affected two weeks back or so. But having taken these measures, the main signal from the RBI and possibly from the authorities in Delhi, was that we want to anchor expectations vis-à-vis the rupee. It is too soon to say whether it is working or not.
From a market perspective, the fears of further action be it rate, be it liquidity, be it CRR will remain till we see the policy document which will get clarity on what exactly are RBI’s thoughts.
Q: Several central banks have already used the rate weapon to put a floor to their respective standing of the fundamentals in India. Irrespective of what happens to growth in the process, will the RBI need to use the rate hike weapon to ensure that the rupee has first stabilised? Should financial stability be given that utmost importance?
Subramaniam: There are two possible diagnoses. One is to say that all that’s happening is predominantly determined by the external environment notably by what the US Fed has been doing. There doesn’t need to be much of a response. One way of interpreting what the RBI has done is that essentially it is in a thankless job.
For multiple objectives it has only one instrument and it is trying to juggle that. On the other hand, if your diagnosis is that it is actually partly external. But, much more fundamentally, what’s going on in India, and then you would have to step back and wonder whether the RBI was in fact right in pulling back.
If you think the problem is much more India driven, there is a fundamental problem with growth, macro economic stability and really you need much more action from the Indian government and the RBI. Some tightening of policy is unavoidable as that is the way you anchor the rupee.
Otherwise markets are skittish. We are heading into an election year. There is no saying where the floor is going to be. So it really depends upon what your diagnosis is. I would frankly lean towards the latter one. India needs to take much more action to kind of stabilise the rupee and re-engender confidence that things are on track.
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