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When the Money Pot is Pricier Than Money in it

By   /  October 7, 2018  /  Comments Off on When the Money Pot is Pricier Than Money in it

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By keeping the policy rates unchanged RBI has surprised many. Economists were apprehensive that the rates could be hiked by quarter of a percentage point. But in a meeting held recently, the six-member Monetary Policy Committee of RBI voted five to one to maintain the rates. However, the country’s central bank has shifted gear by changing the stance of the policy from “neutral” to “calibrated tightening” thus reinforcing its commitment to restrain the inflation rate even as the present rate turns out to be tamer than anticipated. Despite the steady rise in crude prices, a depreciating currency, increases in minimum support prices of crops and house rent allowances to government employees, the country’s retail inflation dropped to a 10-month low of 3.69 per cent in August and RBI is projecting a 3.9 to 4.5 per cent retail inflation in the second half of the current fiscal and 4.8 per cent in the first quarter of 2019-20, lower than projected in August policy. But gear shifting also suggests that RBI does not rule out risks of inflation. The inflation targeting means that RBI is not in a hurry to rescue the falling rupee. RBI, as the Governor indicated, would rather let market forces decide an appropriate level for the rupee. Intervention, if any, would be to curb excessive volatility rather than achieving a specific level. There may be several reasons for this. The rupee slide improves the country’s export competitiveness; also India’s foreign exchange reserves at more than $400 billion are enough to take care of 10 months’ imports and according to RBI, the rupee has come under pressure because of external factors such as high oil prices, volatile global financial markets and intensifying trade wars and finally, the Indian rupee has performed not-too-bad as compared to the currencies of other emerging markets. By September the rupee depreciated in nominal effective terms by 5.6 per cent since end March and in real terms, by five per cent. The fall in the rupee thus has been moderate and what we have been seeing is an exchange rate adjustment. However the areas of concern remain. RBI has acknowledged dislocation in the corporate bond market hit by asset-liability mismatch. Wiser from a series of IL&FS defaults leading to near collapse of short term money market, the RBI now prods NBFCs to rely more on equities and long term debts as a means to raise resources instead of short term funds. Also, one wonders if too much focus on inflation ignoring other parameters is warranted. A record low rupee entails a vicious cycle of costlier crude import, fatter fuel subsidies, worsening of already bloated budget deficit, higher bond yields , flight of investors from equity and debt markets and ,as a cumulative effect of all this, further weakening of the rupee. No wonder the stock market crashed on Friday itself.

 

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