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First impressions

Governor Raghuram Rajan targets rupee,growth and inflation — and ends up leaving many confused.

Written by The Indian Express | Published: September 21, 2013 2:09:03 am

Governor Raghuram Rajan targets rupee,growth and inflation — and ends up leaving many confused.

In his first monetary policy announcement,RBI governor Raghuram Rajan has partially rolled back some of the tightening measures brought in to defend the rupee. Though two partial reversals,in the MSF and the daily CRR,would mean a slight easing of policy rates,it is not clear if this means banks will lower interest rates. Many of them had not raised rates after the July hike. With the partial reversal,and by raising the repo rate,Rajan has signalled that the rupee remains a concern for the RBI. Tight liquidity may be here to stay,dampening market hopes that the tightening was temporary and Rajan would adopt a pro-growth stance. Markets have reacted negatively,with a drop in the Nifty and a bigger drop in banking stocks,especially in PSU banking stocks,where it is likely that the government will not let them raise rates to cover higher costs of borrowing (compared to the June cost of borrowing).

The framework for monetary policy remains confused. It now appears the RBI is targeting CPI and WPI inflation,GDP growth and rupee volatility. While Rajan has clarified that the RBI’s target for the Urjit Patel group on monetary policy operational framework was a WPI inflation rate of 5 per cent,he did not specify a target rate for CPI inflation,for growth or for the rupee. For now,these objectives are to be achieved through eight instruments: the repo rate,which will eventually become the only instrument,the reverse repo,the MSF or bank rate,the CRR and their daily balance,the amount that can be borrowed through the repo window,the amount that banks can borrow through the MSF window,and the SLR.

The direction of policy also remains confused. Should banks raise deposit and lending rates in response to the monetary policy,or lower them? Should businesses make plans expecting lower inflation and higher interest rates,or should they expect higher inflation and lower interest rates? The policy states that changes can be made anytime,and not only on policy days. Rajan’s view,that India is prepared for the Fed tapering after the recent steps,suggests currency markets will remain shallow and businesses may see large volatility in them. Good communication is crucial to managing expectations and monetary policy must convey what the targets,instruments,and direction of policy are going to be.

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