By Ruma Dubey

Yesterday, the Prime Minister met the Finance Minister and RBI Governor. The market was disappointed that post the meeting nothing was announced. Well, you have it today and there is more disappointment today than yesterday.

Many felt that the PM had invited both of them to resolve their differences and some even felt that RBI will magically announce rate cuts and Chidambaram will announce a slew of new projects and FDI liberalization. Now that is really being either very stupid or day dreaming. Miracles do happen but not always the way we want it to happen.

So today morning we all woke up to announcements alright but very sobering ones. First RBI announced measures, harsh but much needed and this time the focus was not on correcting inflation but curb the volatility in the forex markets.

RBI had a two-pronged strategy – it first hiked the Marginal standing facility (MSF) rate and this is at 300 bps above repo rate. This in turn means that MSF with immediate effect, will stand at 10.25% v/s 8.25% and so does the bank rate. MSF is the rate at which the scheduled banks could borrow funds from the RBI overnight. Bank rate is the interest rate which RBI charges on the loans and advances to a commercial bank.

The second step taken by RBI was to limit funds under Liquidity Adjustment Facility (LAF) to 1% of Net Demand and Time Liabilities (NDTL). This will come into effect from tomorrow, 17^th July. LAF is a facility extended by RBI to the scheduled commercial banks (excluding RRBs) and primary dealers to avail of liquidity in case of requirement or park excess funds with the RBI in case of excess liquidity on an overnight basis against the collateral of Government securities including State Government securities. Basically LAF enables liquidity management on a day to day basis.

RBI has capped allocation of funds under LAF at Rs.75,000 crore. This means that liquidity within the banking system will get tight. The daily liquidity borrowing by banks under RBI's LAF is currently close to about Rs 1 lakh crore. RBI has taken this step as it feels that demand for forex has gone up partly due to domestic liquidity improvement so clamping this down would automatically mean curbing demand for forex.

On 18^th July, RBI will also conduct open market operation (OMO) of Rs 12,000 crore. OMOs are the market operations conducted by the Reserve Bank of India by way of sale/ purchase of Government securities to/ from the market with an objective to adjust the rupee liquidity conditions in the market on a durable basis. When the RBI feels there is excess liquidity in the market, it resorts to sale of securities thereby sucking out the rupee liquidity. Similarly, when the liquidity conditions are tight, the RBI will buy securities from the market, thereby releasing liquidity into the market.

Post all these moves by the RBI Governor, Mr.Chidambaram also held a Press Conference and basically listed down all the moves he plans to take or has taken. All plans ultimately got pushed onto one unpalatable plate – the Parliament session which opens on 5^th August. We all know this session will be only about the Food Bill. So basically, FM’s conference was full of rhetoric’s and no real action plan as such.

Foreign brokerage houses were swift to react and they all, like cattle in a herd, cut India’s FY14 GDP forecast. The already despondent moods on Dalal Street got further depressed. Well, today the clouds are indeed darker but one should not blindly follow the herd. Yes, for now growth would be hurt but what the foreign brokerages houses do not see is the fluid and apt action taken by RBI. This was a much needed move to arrest the rupee fall. At least the RBI did something unlike the Govt which only indulges in rhetorics. And this is a temporary move; a quick medical aid to stop the blood flow. Once it serves its purpose, the restrictions would be lifted. Banks are rushing in right now to hike rates; SBI chairman has categorically stated he will be not be hiking rates as he feels this is a temporary move. It could be a few days or a week, a fortnight, a month or even a quarter. But we need these moves to right now to curb the rupee.

Be wary of moves made to merely pump up sentiments and markets; a hallmark of politicians. But be happy that we have one institution at least which does its job right.

We will experience short term pain but maybe it’s the right time then to accumulate long term sound stocks. Things do not always remain despondent; moods will change and so will things.

PS: All eyes and ears are now on Bernanke who is scheduled to deliver his semi-annual testimony on monetary policy before the House Financial Services Committee on Wednesday and to the Senate Banking Committee on Thursday. Expect nothing.