RBI Maintains 'Status Quo', Advises Waiting Till Capital Flows Stabilise

In line with majority expectations, the RBI has kept key policy rates unchanged in its first quarter monetary policy review in a meeting held today. The markets had come to a standstill in the morning as some had expected a hike in the repo rate. However, the 'status quo' announcement had taken the markets in to a positive territory for a while only to slip back into red.

The focus of the monetary policy has completely been on the state of external conditions. The RBI had yesterday announced that its focus is neither growth nor inflation at this time. The depreciation of the rupee against the dollar is its major focus. Earlier this month, the RBI tightened the liquidity conditions in the country by raising bank rates as well as the marginal standing facility (MSF) rate by 200 basis points to 10.25% (effectively 300 basis point over the repo rate). Within a few days, the RBI came out with other measures of liquidity tightening wherein banks are required to maintain a minimum daily CRR balance of 99% of the requirement, up from 70% earlier.

After today's monetary policy meeting, the repo rate remains at 7.25%, reverse repo rate at 6.25% and CRR at 4%. The liquidity tightening measures, however, have indirectly raised the CRR approximately by 50 basis points.

The RBI's stance has remained dovish as it has also lowered its growth projections from 5.7% (May 2013) to 5.5% for growth in FY14. The apex bank sees further risk to the economy due to macroeconomic factors. It is also not clear whether the capital markets have factored in the full impact of prospective tapering of the QE or whether they will react to every future announcement of tapering by the US Fed.

The RBI's policy in the last 2 years was shaped by the growth-inflation dynamics. With the easing of the most concerned factors (inflation), there was a scope for cutting the rates further. The central bank has, however, said that the current situation in the country is a classic case of 'impossible trinity' under which there can’t be a fixed exchange rate, free capital movement and independent monetary policy. This means that the impact on one of these will lead to an impact on the other factors. The RBI has therefore raised short-term rates to attract foreign capital which would help in curbing rupee volatility.

The key question now is regarding RBI’s rolling back of the current policy measures. This is a tricky query that will be addressed when capital flows return to the markets and the rupee stabilises. That is when the RBI will start easing the current liquidity measures in a calibrated manner as guided. For now, ’wait' is the word.