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At sixes & sevens

Posted on January 19, 2011 | View 398

The January 25 monetary policy review may be the trickiest for governor Duvvuri Subbarao in his 30-month tenure at the central bank. He got behind the wheel when the financial world was crumbling. The wisdom then was ‘just throw money’. Now, Subbarao can’t please all. Will he be with the masses, or the markets?

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Duvvuri Subbarao in 2008 was dragged into the Padmavyuha — a defensive formation erected by the Kauravas in the Mahabharat war — by the Federal Reserve’s Ben Bernanke and Jean Claude Trichet of the European Central Bank. Going by the state of the economy in the West, Mr Bernanke and Mr Trichet are doomed to be there for a long time. Mr Subbarao began an exit last January, but doesn’t seem to have succeeded yet. The former bureaucrat raised policy rates six times in 2010. With soaring prices, liquidity crunch, hot money flows, fiscal and current account deficits threatening to de-stabilise the markets, the efforts, so far, look half-hearted. 

In a similar position, YV Reddy, the former governor asserted “getting dal-chawal at affordable rates is more important here.” Market players hated Mr Reddy for spoiling the party, but sing hosannas now. This may be Mr Subbarao’s turn to grab the glory.

INFLATION 
Rate hike may put pressure on businesses 
High inflation is threatening to spoil the India growth story. Even as the Reserve Bank of India is given the credit for protecting the economy from a financial crisis, it has not managed to keep in check inflation and inflation expectations. Though much of the close to double-digit inflation numbers currently is due to supply side factors, demand side pressures are surfacing. This is evident in a rise in credit and cash with the public. Though a rate hike seems to be one of the tools that everyone expects RBI to use, there could be a pressure on funding cost for businesses.

LIQUIDITY 
Monetary tightening may be on the way 
After having comfortable liquidity conditions earlier in 2010, liquidity conditions have turned tight. In December, daily borrowing from RBI was over 1 lakh crore. Liquidity has remained tight in January as well. This is partly due to a rise in currency at the cost of deposits. Also, RBI is preferring tight liquidity. Increases in deposit rates in November and December are expected to ease the situation. Though there is no clear consensus on how the liquidity conditions will emerge, it is likely that RBI will signal further tight conditions by raising rates to tackle high inflation.

CAPITAL FLOWS 
Fear of capital outflows lingers 
Like other emerging market peers, India, too, had huge capital inflows during most part of the year. But a wide current account deficit helped it absorb these inflows without much disruptions. Hence, India did not impose capital controls like others. But with inflows slowing, RBI could face a two way challenge of handling high inflows and sudden reversals. With the India story selling strong, there could be a surge in inflows. But a consistent low growth in industrial output coupled with high inflation could trigger outflows. Also, a slowdown in stable inflows, such as FDI, is a worry.

IIP 
Industrial output swings may hurt 
A volatile industrial output data may be a bigger challenge for RBI. Since June, volatility in growth of IIP has been in the range of 15% to 2.7%. Volatile elements are also changing. While it was due to capital goods production earlier, the November figures were pulled down by consumer nondurables. From RBI’s perspective, credit delivery to various sectors will be weighed in while framing policies. A sustained recovery in industrial output is important to maintain growth momentum. Lack of clarity in this crucial parameter could impact its assessment of the economy and frame policy.

CURRENT A/C DEFICIT 
Long-term inflows must to fund deficit 
THE RBI is not responsible for controlling the current account inflows, in the way it can manage capital account flows. But it has to act if the current account deficit widens beyond a threshold. It is already close to 4% of GDP, the highest ever. However, it is being funded largely by short-term inflows, rather than long-term stable FDI. With global commodity and crude oil prices still rising, this figure could go up even further. The central bank will have to encourage long-term stable inflows, such as FDI, to fund the deficit to avoid disruptions in the external sector.

RUPEE 
Ensuring stable currency a challenge 
The rupee has seen one of the highest volatile periods in 2010 ever since it’s got market determined in the early 90s. Starting the year at strong levels against the dollar, Greek sovereign crisis in April, which threatened to spread to other parts of Europe, hit the level of the rupee as well. September onwards, flows across emerging markets and also a few large IPOs led to a surge in capital inflows. Also, the rupee firmed against the dollar. However, with inflation worries, there is some pressure on the rupee. Major challenge for RBI would be to ensure rupee is steady.

TAKE OF TWO GOVERNORS

Y V REDDY GOVERNOR RBI 2003-2008 
Are you indicating that the common man should get used to higher cost of living? 
Dekhiye bhaiyya, aap bazaar jate hain chawal ka daam badh gaya, tel ka daam badh gaya, dal ka daam badh gaya, toh paise ka daam badhna nahi chahiye? Toh balance rakhna hai na, wahi kar rahe hain

D SUBBARAO GOVERNOR RBI 2008-PRESENT 
When I meet other central banks, they tell me ‘Why don’t you give us a bit of your inflation?’ That’s how desperately they want some inflation and how desperate we are to control inflation. The challenge is to calibrate monetary policy, taking into account the demands of inflation management and the demands of supportive recovery

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