Rupee Dearer Growth Sufferer

Dear Mr. Subbarao, your last monetary policy review as Central Bank Governor can be exceptional if only you could dare to lower down policy rates in order to get our slackening growth back on fast-track. That’s the only panacea Sir while rest is just nostrum.

Rupee Rescue Mission on the part of Reserve Bank of India (RBI) is on. While it can’t admonish foreign investors on their exit-spree but at least it can twist ears of internal perpetrators putting downward pressure on rupee. RBI, in order to prevent speculation in currency market causing pseudo demand of rupee, tightened liquidity via putting restrictions on banks to avail and let availed easy access of money. Also, RBI is of the view that concomitant raise in interest rates giving arbitrage advantage to foreign investors might persuade them to stay invested in Indian debt market. However, these measures have been taken at a time when market was hoping for a rate-cut and has gone highly discouraged on the prospect of increased borrowing cost. Given that one week has gone yet no major improvement could be seen on rupee front, it seems that these measures instead of bearing fruits will rather end up crimping country’s growth which is already running at its decade low.

To explain in detail, following three key steps have been taken by RBI governor D. Subbarao to tame rupee volatility. Firstly, he has put a cap on overnight transaction between RBI and banks and also among banks themselves. The overnight borrowing limit for the system now stands at 75,000 crore for the entire banking system. Earlier there was no such limit. “The allocation to individual banks will be made in proportion to their bids, subject to overall ceiling.” Secondly, in case any bank falls short of liquidity, it will have to borrow money from RBI at steeper rate through Marginal Standing Facility (MSF) window. MSF is an emergency liquidity facility under which banks can borrow from RBI for short-term by pledging government securities. MSF rate, which is 1% above the repository rate (7.25%), has been raised by 200 basis points and now stands at 10.25%. Thirdly, RBI intends to sell bonds worth 12,000 crore under its Open Market Opertaions (OMO) i.e. auction of government securities in secondary market. However, it could only suck out Rs 2,532 crore through OMO, which is about a fifth of the Rs 12,000 crore as bond investors are looking for higher yields which RBI refuses to accept.

Ironically, though these measures didn’t help much where those were supposed to but their after-effect will surely lead to banks’ balance sheet getting embattled. Banks are already suffering losses at loan-recovery front due to enormous extent of Corporate Debt Structuring (CDR) of various companies and current raise in lending rates won’t bring them more borrowers. Thus their profit earned by interest on loans might not increase in the proportion of their liability to pay interest on deposits leading to Net Interest Margin (NIM) coming negative. Also, due to tightened liquidity, banks will have no other option but to resort to escalating deposit rates in order to rein in their capital shortage. Apart from this, higher borrowing cost will not only affect consumers’ purchasing power but also make it tough for industries to keep up with production in the want of cheap credit. It’s worth mentioning here that India’s industrial production has already slumped to negative side if compared to last year and is all set to slide down more.

Now that RBI’s rupee- rescue mission is being faded out as a non-event with no major development in sight, RBI is stuck in catch-22 situation where neither can it terminate these measures abruptly, nor can afford to go on with it. It seems that rupee’s rout has become a structural challenge and nothing much can be done to stem its volatility. Only lessons can be learnt that huge reliance on foreign capital while domestic economy is off-track can bring serious repercussions at any time with no preparation beforehand to tame them. It is pertinent to improvise on internal resistance against maladies as external weather can’t be controlled. On this note, dear Mr. Subbarao, your last monetary policy review as Central Bank Governor being held on 30^th July can be exceptional if only you could dare to lower down policy rates in order to get our slackening growth back on fast-track. That’s the only panacea Sir while rest is just nostrum.