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RBI On Forex Rates and CRR Hikes

I wrote at Yahoo about "Why Only Interest Rates?" (Will post article tomorrow). I just noticed that the RBI released an audio recording of a post-policy teleconference.

A question was asked: Rise in rates will result in appreciation in currency. Will RBI allow that? Will imported inflation reduce?

Answer from RBI: we don’t intervene in forex markets with the objective of setting interest rates. To the extent that we have intervened it is to offset volatility. If there is an inflow from interest rate arbitrage, we won’t intervene. Yes, if currency moves up it will reduce imported inflation and curb demand.

We haven’t seen a big change in the forex rates, and Current Account Deficit is kinda-sorta matched by the Capital inflows. Yes, a rate appreciation would help but even when there is a relatively open capital account.

My take: I’ll believe it when I see it (that RBI won’t intervene). But yes, they seem to have not really intervened in the markets directly recently (though reserves have risen). Will they continue to NOT do so if the rupee sees 40?

Second, we don’t have a "relatively open capital account". People aren’t allowed to hold rupees outside India, foreigners aren’t allowed to buy our traded debt (government or private), we aren’t allowed to go abroad and raise large amounts of money. The statement is like saying tigers are very calm inside a cage. Of course we’re calm, there’s no wiggle room!

Question: Wouldn’t it be useful to change CRR?

Answer: We have to distinguish between liquidity and demand control. Liquidity is the basis on which a financial institution would expand credit. In that context liquidity is in a deficit since May 2010. Given that, we don’t see any significant benefits with moving up CRR, which could also be disruptive because of uncertainties in cash availability. Transmission from policy to lending rates is strong – we saw banks moving up rates nearly immediately.

My take: I don’t really agree. First, disruptive is a strong word; but it does help to have liquidity taken out of the system, in any case. Repo rates work the demand situation; that is, they reduce customer demand for credit. But they don’t really make banks want to lend lesser, or worry about their capital ratios, which is what needs to be promoted if credit growth needs to really moderate. A 0.5% hike in CRR would have taken out just Rs. 25,000 crore from the system, which would then have to be borrowed at the 8% rates, keeping banks in check better.

(I’ve phrased it my way)

  • Arghya says:

    Yah Deepak, I agree with your take on CRR. I think RBI also worried about market; they don’t want the market to make hard landing which I believe is also justified. Anyway they have to do it, preferably later.
    See now no monetary policy would help. We have to suck out excess money from the system by any means. I am not fully agreed with you regarding fully convertibility of rupee right away. It could be a disaster; Indian economy is still not mature enough to leave it on market’s demand-supply rule; but efforts should be made to move in that direction.
    I would not put much emphasis on NREGA. Come on; there is no dearth of labor supply in India, it would not have significant impact on agricultural output anyway. Let some lucky poor fellow have full meal. You are forgetting much bigger issues –
    1) Bailing out farmers – increase in liquidity at the very lowest level, highest velocity of circulation. Farmers (mainly rich) now would take as much as loan they can take without any worry of ever paying back any money.
    2) Manifold increase in salary of government employees without any accountability – liquidity at lowest level with highest velocity of circulation. High inflation is inevitable outcome. The excess money earned by government employees would direct result in inflation and it would not stop as long as the purchasing power of non-government wage earners come to the equilibrium point as it was earlier before salary increase of gov-employees.
    3) mega-scams – velocity of circulation is lowest but still it matters. Eventually the money would flow into economy and fuel inflation.
    4) Common wealth game – relatively higher velocity of circulation w.r.t mega-scams as this is a huge collection of tiny-scams. Some upper middle class people of north-India (mainly NCR) have got huge liquidity in their hand. Inflation would flow from this region to rest of India.
    RBI can’t control it anymore. It would fade away naturally when equilibrium point attained in term of purchasing power which has been distorted by several means in recent past. In my mind, I am thinking that still one and half year such inflation is to stay irrespective of any measure taken by RBI. I only hope that they don’t do anything stupid (and that means intervene in Fx-market or making rupee fully convertible.). Equilibrium point would be reached automatically.
    Said too much…. I would stop here.

    • Farmer bailouts are fiscal policy (bigger issue is fertilizer subsidy, honestly), and lesser in size as NREGA. Much of the money here is unbanked, so there’s not that much velocity of money.
      Govt. employee salaries get hiked according to pay comm recommendations, they are typically underpaid for long periods and then reasonably paid for short ones. It’s a good thing because it forces the govt to reduce hiring and perhaps even cut people.
      Full convertibility of rupee can be achieved in a year. Just set up four quarterly policy moves, allow foreign markets to hold and trade the rupee, free restrictions from foreign ownership of Indian debt, and we’ll be fine. I suspect any statement that says “we are not mature enough” – because no one is allowed to make that call. Rajiv Gandhi once said India is not ready for a free press because it’s not mature enough or something – that stinks of control, and so does RBI chains of the rupee. Maybe in 10 years we’ll laugh at how restrictive India was!
      Typical reversionary methods mean that we will overshoot on tightening, very harshly, so growth will come down substantially. I think the next two years see GDP growth contract to less than 6% while inflation stays high for the first year or so and then corrects. But that’s just an opinion.

  • manish motwani says:

    sir, i wanna know all market terms and their use will u plz suggest any such information regarding it.

  • Arghya says:

    Deepak, I don’t know the actual expense of different policies such NREGA or farmers bailout or fertilizer subsidies; which I agree is a decisive factor. (anyway a quick google search did not revealed anything. How do you get those numbers? From budget report?) I just want to emphasis that we should not emphasis on NREGA as we make much bigger blunders elsewhere. I know whatever amount might have been allotted for NREGA, more than 50% would be vanished in middle but at least some poor would be benefited, would get full meal for some days.
    I don’t think government employee’s salary is justified. They are awfully inefficient. They don’t even deserve what they were getting even before hike. Now-a-days engineers from a middle tire engg college find it hard to get a salary of 25k. How a primary school teacher (many of whom can’t write a letter in English, just an example of capability, please don’t make meaning word by word) same salary is justified!!! I am not buying that argument. There is no shortage of labor in india. All government employees could be replaced with twice efficient individuals with half salary. No cost-cutting argument is valid. For instance – I know in west Bengal, well qualified para-techers (not permanent) get only ~5K month, even though they are more qualified and efficient than permanent teachers who do nothing but force these para-teachers to do all the works(take classes, labs, check papers) but earn more than 25K. Ground reality is much-much different than statistics. My father-in-law is also school-master, he just can’t decide what he would do with so much money now he gets!!! Anyway if you think their salary was not justifiable (too low) then why they fight against privatization where salary is determined my market demand-supply!!!
    See there is no depth in our market. If we make it open develop countries can easily direct market movement according to it’s will and according to it’s favor. India has foreign reserve 316 billion where as apple as 72.6 billion cash reserve!!! Yes I agree with you that we should move to fully convertibility, but one year is too small. It requires at least 5-10years and that is if and only if we sustain such kind of growth. It’s not an easy job. A wrong move can destroy everything. God have mercy on Zimbabwe!!!!
    Ohh that’s a great insight!! It’s always nice to know your opinion. Seems like when this government would ends it’s term it would leave India at below 4% DGP growth, the great “Hindu-rate of growth”. 🙂