Indian Economy: Monetary Policy

British Deputy High Commission Mumbai

September 2013

Summary

Governor Rajan surprised markets with his maiden monetary policy decision to hike the benchmark interest rate by 25bp in a bid to curtail inflation. Emergency  currency defensive measures partially rolled back as expected.

Detail

Governor Rajan surprised markets on 20 September with his decision to hike the benchmark interest rate by 25bp. The policy statement had a strong focus on anchoring inflation expectations, pointing out that retail inflation, measured by the CPI, has been high for a number of years, entrenching elevated inflation expectations and eroding consumer and business confidence. The policy also noted that the need to anchor inflation and inflation expectations has to be set against conditions in the industrial sector and urban demand.

As expected, the RBI partially rolled back tightening measures put in place to defend the currency.  The policy pointed out that the Bank had committed to maintain tight liquidity conditions until measures to improve the current account deficit  and ensure stable funding were in place.  Since most measures are now in place and the external environment has improved, a calibrated easing was appropriate.

The  Marginal Standing Facility (MSF) rate was reduced by 75bp to 9.5%. The rate was raised by 200bp in July.  The MSF rate is the rate at which  banks can borrow from the RBI against government securities which are part of their compulsory Statutory Liquidity Ratio (SLR). However, in mid July the RBI not only raised the MSF rate, but also restricted borrowing under the cheaper repo window to 0. 5% bank book, meaning all additional borrowing would be at the higher MSF rate.  This pushed up effective policy rates and consequently short end market rates.

The minimum daily maintenance of the cash reserve ratio (CRR) prescribed by the RBI was also reduced  from 99% to 95 %. The guidance stressed that the intention was to normalise the conduct and operations of monetary policy and allow the repo rate to resume its role as the operational policy interest rate.  Further unwinding of the exceptional measures will be contingent on market conditions.

Reactions

India’s corporate sector  were disappointed with the RBI’s decision to hike benchmark rates and the hawkish stance.  Most analysts however noted that a partial roll back of the liquidity tightening measures, particularly the reduction in the MSF rate would reduce the overall  cost of  funding for banks and bring down short term interest rates , despite the increase in the benchmark repo rate.

Disclaimer

The purpose of the FCO Country Update(s) for Business (”the Report”) prepared by UK Trade & Investment (UKTI) is to provide information and related comment to help recipients form their own judgments about making business decisions as to whether to invest or operate in a particular country. The Report’s contents were believed (at the time that the Report was prepared) to be reliable, but no representations or warranties, express or implied, are made or given by UKTI or its parent Departments (the Foreign and Commonwealth Office (FCO) and the Department for Business, Innovation and Skills (BIS)) as to the accuracy of the Report, its completeness or its suitability for any purpose. In particular, none of the Report’s contents should be construed as advice or solicitation to purchase or sell securities, commodities or any other form of financial instrument. No liability is accepted by UKTI, the FCO or BIS for any loss or damage (whether consequential or otherwise) which may arise out of or in connection with the Report.

Countries: India
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