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RBI will have to balance growth, inflation and rupee

Business leaders, home loan borrowers and economists all seem to have one question in mind: Will a change at the helm at the Reserve Bank of India mark a turn towards lower interest rates? Gaurav Choudhury writes.

business Updated: Aug 08, 2013 01:41 IST
Gaurav Choudhury
interest rates

Business leaders, home loan borrowers and economists all seem to have one question in mind: Will a change at the helm at the Reserve Bank of India (RBI) mark a turn towards lower interest rates?

There is anticipation that new RBI governor Raghuram G Rajan will usher in a pro-growth tilt in India’s monetary policy, but analysts are of the view that there is little that the new central bank chief can do differently from his predecessor to steer the economy caught in a pincer attack of a falling rupee, sliding growth and high inflation.

Investors would be keenly watching for forward-looking cues on Rajan’s stance in the mid-quarter credit policy review on September 18, less than a fortnight after he takes over as India’s topmost monetary officer on September 5.

“The most important problem that the RBI governor will have to address is that of managing the current account deficit (CAD) — the difference between foreign currency inflows and outflows. It’s a far deeper structural problem of which the falling rupee is a symptom,” said a senior policymaker, who did not wish to be identified.

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Rajan’s recent stint at the finance ministry has led some to perceive him as being more dovish compared to his predecessor D Subbarao who has firmly been on the side of cooling prices in the contest between rising inflation and plunging growth.

Rajan faces the classic monetary trilemma: stablising foreign exchange rates, boosting growth and containing inflation. On Tuesday he said there was no “magic wand” to solve the immediate problems afflicting the economy.

A weak rupee, which has fallen 15% since May can fan inflation by making fuel and other imported goods costlier.

The RBI has already made funds costlier for banks to stem the rupee’s slide, and more such steps can force banks to raise lending rates, thereby pushing up loan EMIs for individuals.

Also, the record CAD may restrict the RBI’s elbow room to prop up the rupee by dipping into its $285 billion of foreign exchange reserves, enough to cover imports for seven months.

Subbarao said recently: “India is currently caught in a classic ‘impossible trinity’ trilemma whereby we are having to forfeit some monetary policy discretion to address external sector concerns.”

Analysts said it was too early to judge the direction of monetary policy once Rajan takes over as the central bank chief.

“In our view, it is too early to pass any judgement. We believe that India’s macroeconomic outlook will determine the likely monetary policy response. We expect balance of payments pressures to continue and hence remain negative on India’s outlook,” said Sonal Varma, economist at Nomura.