RAJAN'S FIRST CREDIT POLICY - FOLLOWS FOOTSTEPS OF PREDECESSOR

By Ruma Dubey

The first Credit Policy from the new RBI Governor, Raghuram Rajan. Expectations were running sky high. And when expectations are so high, disappointment is certain.

Like his predecessor, Dr.Subbarao, Rajan too kept his eye on inflation and hiked repo rates by 25 bps to  7.5%.  The market was shocked. Then in Marginal Standing Facility (MSF) rate, expectations were around a cut of around 50 bps and it came in much higher at 75 bps at 9.5%.  MSF is a tool wherein banks will be able to borrow upto 1% of their respective Net Demand and Time Liabilities.  This is used to reduce volatility in the overnight rates and improve monetary transmission.

During his first speech, Rajan had talked about growth and today’s policy shows that he too will concentrate on controlling inflation. And this is what has grossly disappointed the market, which will now be equally quick to pull him down from the pedestal where it had put Rajan on. But that placement on pedestal was misplaced to begin with – how can Rajan, with just one policy undo all the economic woes? Did the market think him to be a magician? This shallowness of the market shocks while we assumed all along that Indian markets are very mature.  Markets rose in an exaggerated way yesterday and ever since Rajan took over. Thus what we see today is a reaction to this exaggerated expectation. But if there had been no such build-up, this is a very pragmatic policy, given the rupee depreciation, high inflation and various curbs to bring down exports.  

A quick highlight of RBI Mid-Quarter policy:

• Inflation will be top priority and that will drive the RBI policies in the coming months.  More repo rates seem quite possible.
• Reduce the marginal standing facility (MSF) rate by 75 basis points from 10.25% to 9.5% with immediate effect.
• Reduce the minimum daily maintenance of the cash reserve ratio (CRR) from 99% of the requirement to 95% effective from the fortnight beginning September 21, 2013, while keeping the CRR unchanged at 4%.
• Increase the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.25% to 7.5% with immediate effect.
• Consequently, the reverse repo rate under the LAF stands adjusted to 6.5% and the Bank Rate stands reduced to 9.5% with immediate effect. With these changes, the MSF rate and the Bank Rate are recalibrated to 200 basis points above the repo rate.
• In the absence of an appropriate policy response, WPI inflation will be higher than initially projected over the rest of the year. 
• The timing and direction of further actions on exceptional measures will be contingent upon exchange market stability, and can be two-way. Further actions need not be announced only on policy dates. However, any further change in the minimum daily maintenance of the CRR is not contemplated.

The markets yesterday rose over 650 points and today, post the policy, it has crashed over 550 points. This is simply being too myopic. All our economic issues remain and the only solace is the postponement of QE tapering. This has given some relief to the rupee. But it is an occurrence which has merely been “postponed” and not cancelled.

Rajan has stated in the policy has stated that there is no room for complacency despite the good crops expected. And most on the street, who are paying through their nose for basic vegetables, will agree. Monetary policy action cannot give impetus to growth it needs to be supported by removal of supply bottlenecks and making investment environment more conducive. Big projects are stuck in a morass and unless and until those projects take off, growth will continue to suffer.

The hard reality – growth will continue to take a backseat and priority will remain inflation; interest rates could remain high for some time now.  There is nothing overtly negative in this policy and the market, as usual has overreacted. On the whole, this is the perfect policy given the macro environment. The Q2FY14 numbers will probably be the worst that we will see and lets brace for that…..