RBI takes the right steps: Indranil Sen Gupta

We compliment Reserve Bank of India (RBI) Governor Raghuram Rajan for walking the tightrope in fighting inflation and reviving growth. Expectedly, RBI cut the MSF (marginal standing facility) rate 25 basis points to withdraw the July measures and raised the policy rate by 25 basis points to contain inflation expectations. We expect it to shift the money market to a repo mode, along with a final 25-basis-point rise on December 18. After all, we expect growth, at 4.6 per cent, to surprise on the downside.

Wholesale Price Index-based inflation would likely be about 6.5 per cent, with the inflationary impact of depreciation offsetting falling agflation. Consumer Price Index-based inflation could fall to 8.4 per cent by March, lower than RBI's forecast of more than nine per cent. Looking ahead, we expect RBI to continue to recoup forex reserves. After all, import cover has halved to seven months, last seen in 1998 and well below the eight-10 months necessary for rupee stability. We also expect RBI to phase out its swap facility for oil firms in November. Our standing call about mobilising non-resident Indian deposits to calm the rupee is vindicated. Now, we expect Delhi to raise foreign investor debt limits to list Indian government paper in an emerging market bond index, so that RBI can raise about $20 billion from benchmark funds tracking such indices. Though the current account deficit would likely shrink to 3.2 per cent of gross domestic product from 4.8 per cent last year, there is a limit to how long gold imports can be curbed.

Finally, we expect RBI to boost liquidity to reduce lending rates and revive growth. Loan demand rose to 16.5 per cent (adjusted for commercial paper), much higher than the deposit growth of 13-14 per cent. Hence, we expect RBI to resume open market operations after it has greater clarity on the forex to be raised through the ongoing foreign currency non-resident (bank) deposit-cum-swap scheme.
Indranil Sen Gupta
India economist, Bank of America Merrill Lynch