Oxygen for a market in intensive care unit

RBI Governor Raghuram Rajan has touched upon almost all the concerns affecting the economy in general and the banking sector in particular

The most important takeaway from the new RBI Governor Raghuram Rajan’s maiden speech is that he has managed to turn the sentiment ship around. He has touched upon almost all the concerns affecting the economy in general and banking sector in particular. Importantly, he has won the trust of the market by his statements which are clearly dovish. Short covering both in the equity and currency markets is visible as speculators sense an end of the bear run, at least for the time being.

 

The focus has now moved from the government to the RBI. But it is the government and its policy actions that will decide the long term trend of the market. Rajan has come late to the party, it needs to be seen how much he can do to salvage of what’s left of the economy.

To begin with, he has given the signal that he is pro-reform and is willing to take risks, even if they are unpleasant. His international experience is at play in his action towards the currency markets. He is not afraid of the markets and speculators, which is a welcome change from the government and RBI’s line of thinking. RBI’s press note reads that it is better that investors take positions domestically and provide depth and profits to our economy than taking our markets to foreign shores. Rajan has announced measures to deepen the forex market by allowing importers and exporters to re-book their cancelled forward exchange contracts.

However, the RBI is only one of the engines on which the economy runs. The driver and controller are the government and its policies. Though  Rajan has tried to cool down currency markets by saying that he is willing to maintain the purchasing power of the rupee, this can also be interpreted through an inflation sight glass. Also, it would mean that the RBI can be more aggressive in controlling the rupee. However, what he cannot do is stop the outflow of dollars from the market. Especially since interest rates in the US are going up and the arbitrage opportunity reduces.

By allowing swapping facility for banks and increasing overseas borrowing limits, the RBI is only addressing the cost of fund issues on a temporary basis, till the window is shut in November-end. Similarly, freeing banking resources from their investment in G-Sec is unlikely to produce results anytime soon, as banks have deliberately invested in these instruments over the statutory limits since they find lending in the economy a riskier option.

 

On the issue of debt recovery and restructuring, he has once again reiterated the point of change of management of defaulting companies. But this is easier said than done, given the political clout enjoyed by most of the bigger defaulters.

Inflation-indexed bonds pegged to the consumer price index no doubt is a good move as far as households are concerned, but this has the potential of raising interest rates across the board as the issuing authorities (RBI and government in this case) would need a counter market to hedge their exposure to such high cost instruments.

 

Issuing new banking licences more frequently, Rajan is showing willingness to open up the sector further, but it is the existing guidelines which would need to be relaxed a bit to attract new players.  

To be fair to Rajan, he has said more than what was expected from him in his inaugural speech. He has set the tone right, but unfortunately he has set the expectation bar higher. Every time he will be on TV, the market might expect new and friendlier announcements. But Rajan may soon discover that meeting these expectations will be a tough task.

As for the markets, the RBI has only provided fresh oxygen cylinders to a patient in ICU. To sound politically correct, the patient is critical but stable. The economy will continue to languish unless the government shows the same enthusiasm as the young governor did to help bridge the trust deficit.