Vigilant Owl !!

RBI Governor  stands out as is India…

Rarely anyone gets credit for averting a crisis . Create one and douse it with all the drive , is a safer style to get noticed . RBI Gov. has chosen the former to stand out .   By standing firm on interest rate and inflation , he risked sounding hawkish all thro the policy events over last few months . Including this column , many believed that RBI had a lot of  leeway to cut rates in the last policy meeting on falling  inflation and moderating fiscal deficit  . Recovery in monsoon  and crack in commodities added to the chorus for rate cut . Without succumbing to the popular sentiments , RBI stood firm on the rates citing global risks and its fallout on currency . Risks of financial flows ( on Fed rate hike fears and on competitive currency devaluation ) weighed on RBI more than anything else .

Events in last few days have exposed India’s vulnerability to such risks . Fueled by fears of slowing growth in china , stocks slumped and currencies crumbled across emerging markets. With FIIs selling across emerging market basket , Indian markets suffered one of the worst falls of this decade . Rupee wasn’t spared either . Reminiscent of 2013 when taper tantrums  ruined the rupee , markets feared  re-run on rupee ignoring the fact that lot has changed since then. Most among them is the surge in confidence on RBI and its Gov’s ability to stem any crisis , besides improved macro fundamentals on soaring reserves and curtailed current account . This has primarily stemmed from RBI’s silent and sustained work on inflation . Rupee’s relative resilience in this rout is a pointer to ponder in this context . Rand to ringgit are all  at multi year lows while rupee has managed to survive with  much less scars in this savage . Not being clubbed in troubled-ten ( infamous ten emerging market currencies that have been slaughtered in this year’s slump)  in itself is a testimony to its rising strength . It would have been a different story for Rupee if RBI had buckled under pressure and pressed ahead with accelerated cuts .What is ironical is that it has gone largely unnoticed that a major crisis has been averted on the rupee by the prized prudence of RBI Gov .

For RBI , the job is half done . It’s reluctance to cut rates stem from two strain points . First is the price pressures at retail level . Though inflation is on the mend , the role of favorable base effect can’t be discounted in the latest soft numbers that came out  in August . Adjusted for the base effect , the inflation trajectory is still above RBI’s glided path target of 6% ( at CPI level) . Second worry for RBI is on the capital flows . While global markets are preparing for gradual Fed rate hikes starting  Sept –Oct , any unexpected spike in US inflation would force  Fed to move faster and  remove accommodation much more quickly ( raise rates faster) than what the markets are pricing in now . Such an outcome would lead to gush of capital outflows and will have the potential to rock the already ruined emerging markets and their currencies  once again .  Hoping that turmoil  not to touch Indian shores will be ruinous .  Add to these , the transmission issues in the Indian banking system where the earlier rate cuts are yet to percolate down  to the final lending rates  ,  one can see reasons on why  RBI is not in a hurry to cut rates  . Given the rising chorus from Industry and Finance ministry , RBI may provide some breather in its Sept policy ( with marginal cut)   , but sustained cuts are sometime away.  Rajan is firm on his path to win the war on inflation to put India on a long-term sustainable high growth trajectory .

On few counts , India seems to stand out  in the murky global macro . India probably is the only country where both growth  and interest rate cycles are just turning   –  growth is likely to accelerate while  interest rates are likely to inch  lower over time . Skeptics  will argue that India had presented such a rosy scenario many times earlier and rarely lived up to its potential . No prizes for guessing who played the spoil sport in all those cases . It was inflation monster. This is precisely  where , this time is likely to be different . With inflation-hawk at the helm of RBI supported by fiscally restraint Govt. , there is rising hope and confidence on India’s ability to win the inflation war this time . This does not mean that India will be insulated in the ongoing financial contagion , but when the dust settles on flows and investors start differentiating , India is likely to emerge as  one of the few bright spots . On sailing thro’ the short-term turbulence , Vigilant Owl ( not the hawk , nor the dove as famously proclaimed by Rajan) will take India to the shores safely.
ArunaGiri . N

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