Comment: Samiran Chakraborty

A hawkish twist

The twin measures of an MSF (marginal standing facility) rate cut and a rise in the repo rate came as a bit of a surprise to the markets, as they appear contradictory. However, it is important to understand the objectives of employing these measures are different.

The purpose of the July rise in the MSF rate was to help defend the currency, while this latest repo rate rise is to address the re-emergence of inflation fears. While the former was an explicit temporary measure, the latter has brought a more permanent rise in the interest rate structure.

We expect this differentiation to continue and, hence, the pace of further MSF rate cuts will be a function of currency movements. We expect the MSF rate to be cut another 50 basis points (bps) by 2013-end and expect liquidity conditions to be eased to bring the overnight call rate in line with the repo rate. This will be possible as the currency benefits from benign global backdrop, improving current account and lumpy rupee inflows.

Forecasting the extent of repo rate rises is more difficult. This will depend on the inflation metric the new governor targets. With our expectation the wholesale price inflation can inch to seven per cent, another 50 bps rise in the repo rate is quite possible. However, if the emphasis is more on consumer price inflation, monetary tightening may become more onerous and protracted.

Bringing down inflation by cutting demand-side pressures when supply constraints are acute is likely to prolong the slow-growth period. We agree inflation is still a concern in the economy but the effectiveness of using interest rates to address food and fuel inflation is open to question.

Also, there is no change of stance on the role of monetary policy to support growth. According to RBI, the near-term obstacles to growth are not in the domain of monetary policy. Monetary policy can only support growth in the medium term by ensuring low and stable inflation. Liquidity conditions might ease from the punitive levels following the MSF rate cut, but monetary policy is unlikely to provide the balm that the industry is looking for.

Samiran Chakraborty
Managing Director, Regional Head of Research, South Asia, Global Research, Standard Chartered Bank