The Street had stayed in vain, hoping some things from the 1990s would not return to haunt it. That was a time monetary policy was dictated by currency management priorities. Between December 1997 and January 1998, soon after the Asian crisis, the cash reserve ratio (CRR) was raised 150 basis points, while the policy rate was increased 200 basis points to arrest the rupee's fall. Fifteen years later, the Reserve Bank of India (RBI) has effectively done the same thing.
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After keeping markets on easy money steroid for five years to tide over a crisis that was unprecedented in recent times, the US economy seems to be recovering. We all knew that 2013 would be dominated by US Federal Reserve talk on pulling back loose money. But when Big Ben (Ben Bernanke) finally spoke of tapering bond buying, risk-averse trades started and the dollar gained. The rupee's fall is a part of this broader global strengthening of the dollar against all emerging currencies. There's very little RBI can do to reverse this, being just as helpless as in the '90s. You cannot fight global flows with local monetary policy.
Here, it's important to monitor RBI's action from the equity market perspective. At present, valuations are polarised like never before, a sign of low investor confidence. The quality stocks, with reasonable earning visibility, are as or even more expensive than at the peak of the bull market, while the rest have never traded so cheap. The market will surge only if there is a sustained rally in high-beta banks and financial stocks. This can never happen till RBI rolls back its measures.
All this boils down to a simple question: when would RBI "roll back"? The stern measures are beginning to hurt the broader economy and bond market. Banks are raising lending rates, while most economists have cut growth forecast. Even one quarter of tight money could be too long for an economy struggling to find a bottom. At some point RBI will have to take a call, as it did in the 90s, on whether it makes sense to inflict more pain on the broader economy to defend the rupee. Chances are the wait might not be too long.
The author is chief investment officer, AEGON Religare Life Insurance
