Friday, September 27, 2013

Raghuram Rajan's maiden monetary policy

Rajan's maiden monetary policy produced a blizzard of instant commentaries. I thought I would wait and see how things pan out in the markets. The wait was worth it. I am not inclined to buy the contention that the policy is primarily about fighting inflation. I think it is more about maintaining currency stability.

Why do I say so? Well, the policy caused short-term rates to fall by a cut in the MSF rate. However, the hike in the repo rate will cause long-term rates to rise. The net effect should be an increase in banks' cost of funds and hence in lending rates. It cannot be otherwise if the policy is anti-inflationary. You can't have an anti-inflationary stance that causes lending rates to fall!

Rajan's maiden policy is undoubtedly anti-inflationary. But I would think that Subbarao's tightening in July was even more so. There was a rise of nearly 300 bps in short-term rates- and it was only a matter of time before long-term rates followed suit. That would have really slammed the brakes on growth. So Rajan has loosened policy somewhat, albeit at the short end.

If the focus had been primarily on inflation, then such a loosening would not have been warranted. The hike in the repo rate, which is meant to offset the cut in the MSF rate, is intended to maintain a decent differential between yields in India and those in the US ahead of tapering. It is a sort of preparation for the inevitable tapering of QE that lies ahead. Evidently, the RBI takes a rather grim view of what tapering would mean for India.

More in article in the Hindu, RBI focus still on currency stability.


Anonymous said...

So are you then saying that there are more worse days for India ahead!

chandramouli said...

2nd October is also the birthday of Lal Bahadur Shastri (LBS). That was one of the worst time that India faced after China Pakistan War. There was acute shortage of food. Rice was not there in ration shops and people consumed Lapsee instead of rice. People used to start standing in queue in ration shops from previous night. The stocks in ration shops used to exhaust within half an hour of its opening and most people used to go back home empty handed. USA suppled red wheat, which was not even fead to cattle in USA, to feed Indian people under PL480. There was cold war between USA and Russia and LBS, probably, was one of its victims. I think you should write a blog on those times for information of the present generation.