RBI kept benchmark policy rates unchanged in its policy review today. The guidance provided by the central bank suggest that apart from growth-inflation trajectory the balance of payment situation will be key to conducting monetary policy in the coming months.
RBI’s focus is on the INR (Indian Rupee). The recent fall in the INR that has fallen by over 6% over the last few weeks to touch all time lows, has clearly raised RBI’s antenna on external shocks to the economy. The fact that GDP growth at decade lows, WPI (Wholesale Price Inflation) at over forty month lows and global growth forecasts being revised downwards by the World Bank has not taken its focus away from the repercussions of a weak INR.
RBI was forced to intervene in the currency markets when the INR threatened to fall below the psychological Rs 59 levels to the USD. The extent of intervention is not revealed yet but any USD selling by the RBI is liquidity negative. RBI in managing INR volatility will also have to keep a watch on the system liquidity given that it is still in deficit by around Rs 75,000 crores. Hence a focus on INR and liquidity takes attention away from economic growth.
Liquidity has in fact improved on government spending and Government’s cash balance with the RBI has come off substantially from levels of Rs 100,000 crores. Subsidy payments to oil marketing companies of around Rs 45,000 crores could have resulted in liquidity infusion into the system. RBI has carried out bond purchase auctions of Rs 17,000 crores over the last two months and this has helped improve liquidity conditions. Liquidity as measured by the bids for Repo in the LAF (Liquidity Adjustment Facility) has eased from deficit levels of Rs 105,000 crores to levels of Rs 75,000 crores.
The fourth quarter 2012-13 current account deficit (CAD) numbers will be released end June. The CAD is expected to fall from highs of 6.7% of GDP seen in the third quarter of 2012-13. Trade deficit numbers for May and June will also be a key for RBI’s July policy stance. April 2013 trade deficit was higher was 72% month on month and RBI will look for the trade deficit to come off on the back of slower gold import growth post curbs imposed on gold imports.
The US Federal Reserve (Fed) will be as important to the INR as the CAD. The Fed is preparing markets for easing of its bond purchase program that stands at USD 85 billion a month. Fed is expected to wind down its purchase program over the next six months and if the markets take this as a too early withdrawal of liquidity, there will be further volatility in global currency markets and the INR.
Markets will watch the INR for clues on RBI policy rates going forward. Bond yields are up 20bps from lows while equities are down over 5% from highs over the last one month. A stable INR with global markets recovering from volatility will increase prospects of rate cuts while a volatile INR on the back of global market volatility will reduce rate cut probabilities.