Reserve Bank of India Opens a New Box of Tools

September 20, 2013

2013 has been a difficult year for the Indian rupee, which despite some appreciation in September is down over 13% against the dollar since end-2012.  The exchange rate has been hit by elevated inflation, disappointing growth, a chronic current account deficit equal to about 4.5% of GDP, and rising global long-term interest rates.  A number of steps were taken in July to support the rupee by tightening Indian money market liquidity, notably the recalibration of the Marginal Standing Facility (MSF) at 300 basis points above the repo rate, which was then at 7.25%.  The repo rate previously had been sliced by 50 basis points in April 2012 and three times by 25 bps each during the first half of 2013, most recently in May.  Today’s mid-quarter review of monetary policy, the first under the new Governor and former Chief IMF economist Raghuram Rajan, was expected to leave the repo rate unchanged.

In a surprise move instead, the repo rate and reverse repo rate were hiked by 25 basis points each to 7.5% and 6.5%.  The cash reserve requirement was left at 4%.  According to an accompanying statement, this hike recognizes “that inflationary pressures are mounting and [is] determined to establish a nominal anchor which will allow us to preserve the internal value of the rupee.”  The repo rate increase coincides with separate decisions that cut the MSF rate by 75 basis points to 9.50% and the minimum daily CRR balance that banks have to maintain to 95% of the requirement from 99%.  Rajan aims to restore the repo rate at the central bank’s main operative policy rate, and the 25-bp hike of such was needed to make its level consistent with India’s rate of inflation, but the released bank statement asserts that the net effect of all measures being taken will reduce the cost of financing yet contain inflation as well. 

The statement acknowledges actions taken earlier this month in areas such as branch banking to liberalize Indian financial markets, and it notes that capital has been flowing back into India.  More steps are on the way: “Over the next few weeks, together with the government, we will take a close look at corporate distress and bank NPAs to see how we can accelerate the process of resolution.  Finally, we are taking a look at a variety of markets to deepen them and make them more vibrant. Measures will be announced periodically.”

The initial reactions of the rupee and Indian share prices to all these changes was not favorable.

Copyright 2013, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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