RBI policy review and my views

There is excess liquidity for sure both in the Indian and Global financial markets today. Thanks to the near zero interest rates in the developed world; it is felt that the developing world is sitting on asset pricing bubbles. So it is more interesting to notice how these bubbles can be spotted today. The 20% food price inflation is not just a problem in India, but the rest of the developing world as well. Also the stock market was defying all logic 3 months ago, but recent quarter results have quelled some fears of over valuations. Moreover even commodities including oil have staged an upward trend in prices, even though the developed world is still healing its wounds. Thus it is a very difficult situation for the RBI to be in today, especially to be overseeing the global economic rebalancing also taking place in Asia’s favour.

Governor Subbarao has dishonourably failed on his most important job of controlling inflation and maintaining the value of the note he himself signs. Such high inflation in a recovering economy can spell misfortune in subsequent cycles.

The inflation is putting increasing pressure on the economy and the common man, which is not a sign of healthy recovery. Also foreign flows of capital into India have been touching enormous amounts, and the weaker dollar is a nightmare for the exporters and RBI alike. But it was as expected that on Friday, 29^th January 2010 the RBI hiked its CRR by 75 basis points, as looks to mop up Rs. 36,000 crores of excess liquidity. RBI had indicated in its previous policy review in Oct 2009, of its intent to gradually withdraw monetary support, but had just increased the SLR back to 25%.

I was expecting 50- 100 basis point hike in CRR, and along with it increases in Repo rates as well. My analysis proved worthy on two grounds. First, the CRR rate would have been increased in a calibrated and gradual manner instead of giving sudden shocks to the financial systems. Second, the RBI would have succumbed to Manmohan Singh’s cabinet to control inflation.

However I do not expect a rise in bank rates and other rates too soon, because then the RBI leaves the door open to even more foreign capital inflows. This would nullify the desired outcome as more money would still be chasing the same amount of commodities. Also it will further cause the rupee to be more susceptible to the volatile dollar currency markets as the foreign investors would be looking to hedge their currency risks and attracting more speculative movements.

Could do better

Although we all feel that the RBI has done well enough to save the economy in the crisis and its previous prudent polices have indeed protected the banking system, but to me its recovery management has failed in many ways. Firstly, India witnessed a slowdown, not a recession, so the work was already half done. Secondly, the earlier populist fiscal policies of the government were more than a helping hand to its monetary policies. RBI’s ineffectiveness was visible initially (in last quarter of 2008) where banks refused to bring down their lending rates; especially at the time economy needed the most. Thirdly, its failure to control inflation is big embarrassment for the usually pompous banker. Governor Subbarao has dishonourably failed on his most important job of controlling inflation and maintaining the value of the note he himself signs. Such high inflation in a recovering economy can spell misfortune in subsequent cycles. What and how it unfolds precisely is difficult to predict just like today’s economic crisis.