A cautious Reserve Bank of India (RBI), mindful of the current account deficit (CAD) and a shaky rupee, on Tuesday once again chose to keep all key interest rates unchanged and asked the Government to take urgent steps to stem the rot in CAD. Disappointed, bankers said they may have no choice but to hike rates after a month to the detriment of retail borrowers and industry.
Subsequently, rupee crashed by a whopping 106 paise to three-week low of 60.47, wiping out all the gains notched up on central bank’s recent liquidity tightening steps while Sensex plunged by 245 points to a nearly three-week low of 19,348.34. lowering the GDP growth projection for the current fiscal to 5.5 per cent from 5.7 per cent, the central bank said the external sector is the “biggest threat” to economic stability.
It also said that the recent liquidity tightening measures, taken to support the rupee, will be rolled back in a calibrated manner as stability is restored to the foreign exchange market, enabling it to revert to the policy of supporting growth with continuing vigil on inflation. This, however, would be done when stability returns to the currency market. It added at the same time that efforts would be made to keep inflation, which is under threat from a depreciating rupee, at 5 per cent by March end.
“The policy stance is guided by the need for continuous vigil and preparedness to pro—actively respond to risks to the economy from external developments, especially those stemming from global financial markets,” Governor D Subbarao said while unveiling what would be his last policy announcement. “Because of the large CAD and the way we financed it, we became vulnerable to the external outlook, global financial markets and the sudden stop and reversal of capital flows and the consequent destabilisation of the exchange rate,” he said. “The rupee dropped from 57 to 61 in a matter of four weeks without any change in our fundamentals.”
At the same time, on the domestic front, there was ample liquidity in the system. “The easy liquidity provided for a fertile ground for speculation on the exchange rate, which exacerbated vulnerability,” he said. Accordingly, the repo rate or the rate at which RBI lends to the system, has been retained at 7.25 per cent and the cash reserve ratio, the amount of deposits banks park with RBI, has been kept unchanged at 4 per cent. The RBI announced measures to drain cash in the evening of July 15, and followed up with additional steps on July 23.
Chief Economic Advisor to the Finance Ministry Raghuram Rajan welcomed the RBI’s steps, saying that in the coming few weeks some steps would be taken towards CAD financing. “We will steps to support exports and discourage imports. Increasing import duty is also an option provided growth does not get affected,” he added. The corporate sector was visibly unhappy with RBI’s ‘inaction’, which reflected in CII Director-General Chandrajeet Banerjee’s comments, who said, “we are disappointed. RBI has also cut down the GDP forecast for FY14 to 5.5 per cent, which is clearly reflecting the reality.”
He said that the economic growth needs to picked up and for that “moderate of interest rates are very important”. Sharing similar views, former FICCI President RV Kanoria said that the investment environment of the country should be improved. “We have to reignite the passion of economic growth by building confidence in the economy. Enhancing investments are the need of the hour,” Kanoria said. Giving the policy guidance, the RBI Governor said, “monetary policy going forward will be shaped by the consideration of supporting growth, anchoring inflation expectations and maintaining external sector stability.”
Subbarao, who is slated to retire days before the next mid-quarter review on September 18, said the policy stance is aimed at addressing risks to macroeconomic stability and growth and guard against the re-emergence of inflationary pressure. It would also endeavour to manage liquidity conditions to ensure adequate credit flow to productive sectors of the economy. The current situation of low headline inflation, prospects of softening food inflation on a good monsoon and decelerating growth warranted a pro-growth policy stance, but for the difficulties on the external front, as reflected in the almost 10 per cent depreciation in the rupee and the rising current account deficit, he said.
Stating that the external sector was the “biggest risk to macroeconomic stability,” Subbarao called for urgent policy steps from the Government to curtail the CAD to a sustainable level of 2.5 per cent of GDP and said that the RBI is ready to use all instruments under its command help in the efforts. “It should be emphasised that the time available now should be used with alacrity to institute structural measures to bring CAD down to sustainable levels,” the Governor said. The second quarter monetary policy is scheduled on October 29, while the next mid-quarter review will be released on September 18.