RBI's short term rate hikes may not be that short
Options are narrowing: Suffer high interest rates for a short period and put the house in order even if it sacrifices economic growth.
That raises the question on the efficacy of the measures of the central bank in stemming the fall of the currency for a longer duration and its ability to actually influence its direction.
Governor Duvvuri Subbarao has said two things: promised to rollback the tighter monetary measures once volatility in the foreign exchange market subsides, and that his efforts are at best a window of opportunity for the government to put the house in order.
Knowing the government's ability to correct the mismatch, one could reasonably conclude that the shock therapy that RBI administered is likely to be in place for a longer term than what the market is wishing for.
The problem is high current account deficit. The government has to take steps to earn more US dollars through exports than perennially relying on the dole from investors.
There are hardly any signs of that because it will take longer and the government is forever looking for financial solutions to a problem of commerce as Kotak Mahindra Bank vice chairman Uday Kotak says.
Investors are drawing lessons from what Governor Bimal Jalan did in 1998 when he rolled back steep interest rates and cash reserve ratio increases in just about a quarter.
But there are vast differences between the two governor's times and actions. The foreign portfolio investments, overseas borrowing and India's international liability repayments next year, is many times more than what it was then. Also, it was not a self-inflicted crisis, but the contagion of 1997 Asian crisis.
The rupee has resumed its slide and possibly could head to new lows unless the government moves quickly to raise US dollar funds because even equity flows will be doubtful with the RBI lowering growth forecast to 5.5%, from 5.7%.
That could be done either done through a sovereign bond issue for about $20 to $25 billion, or NRI bond sale, which will again provide only a window, albeit a larger one than what the RBI has provided.
The other option is for the RBI to go for a textbook response by raising structural interest rates – the repo rate – that could have lured foreign funds because of the yield, rather than managing the optics to please the political class.
We in India have been fed the growth opium by policy makers far too long to paper over their fiscal profligacy and monetary mismanagement. The time of reckoning has come.
Options are narrowing: Suffer high interest rates for a short period and put the house in order even if it sacrifices economic growth. Else, the market will force us to suffer through depreciating Rupee. Anyway, economic growth has halved. So, what if it slows further that will lay the foundation for long term prosperity.
If policy makers do not realise the magnitude and act, we will be where we were in 1991 – an International Monetary Fund bailout.