RBI got checkmated?
Well the title of the article says it all .Yes , we are talking about present dilemma which is eating away the calmness of World’s 6th largest economy’s central bank .
2 years back when Mr. Urjit Patel took over Mr, Raghuram Rajan under the demonetisation aftermaths ,the thing that he would have least desired was worsening of India’s fundamentals .Everything went on the desire lines in 2017 and RBI job was just thought to be that of an idle watchdog .Come 2018 and everything changed for India’s macros.
It all started with U.S federal bank raising it’s interest rate a year back ,but what was least expected to economies world over was the positive effect of Trump’s tax cuts on the U.S economy .Some where down in February U.S federal bank started giving hints of more than faster pace of rate hiking under the influence of better than expected performance of the U.S economy .It took 3-4 months since U.S fed commentary in Q1 2018 that the fragile developing economies of the world with high current account deficit started starving for the U.S dollar as all the FII/FDI investments across these developing economies started moving out .Now many layman would be asking what is relation between higher U.S interest rates and Dollar moving out from the developing economies?
Well answer is that after 2008 U.S crisis, central bank of U.S went ahead with an extreme liquidity boost for the U.S economy and reduced Fed interest rates to nearly zero .Years went by and this U.S fed move started working in favour of U.S economy as it made liquidity available for the U.S companies to get out of the after crisis effects .This very fact of ample liquidity in U.S with nearly 0 interest rates return on investments ,most of big FII/FDI’s of U.S started looking out for other economies around the world for better returns on their investments and this search landed them on the investment shores of the developing economies like India, China,Brazil ,South Africa types as central bank interest rates of these developing economies were far lucrative as compared to U.S fed rates even if taxation part of investing was taken into consideration by these FII/FDI’s .
Now as U.S central bank started increasing it’s interest rates and gave signals of doing it at faster pace than expected , all the eyeballs of these FII/FDI’s again turned back to their home country as now their investment can fetch better returns in their home country itself and they need not have to worry about taxation problems even. So in bit of technical terms ,”Arbitrage” advantage enjoyed by the emerging markets started diminishing .This led to the dollar outflow from emerging becoming more aggressive and in the process the balance sheets of these emerging markets started getting starved for the dollar and came to the reality test of their fundamentals.Those emerging markets with weak fundamentals and high current account deficit were first to get bust off .Countries like Argentina,Turkey ,Philippines ,Indonesia were first to crack off as they were not able to cope of such a high volume dollar fly off as their central bank balance sheets didn’t had the dollar reserves to make stabilize .So their currency crashed as it starved for the dollars.
After testing and wiping off the currencies of all the major emerging markets across the world ,fundamentals test were all ready for another big emerging market “INDIA” and the battle of sustaining this tsunami started. One advantage that India enjoyed in comparison to other emerging markets was the solid $400 Billion Dollar reserves with it’s central bank. India was all capable of battling out any outflow as fundamentals supported it’s back ,but somewhere down in July ’18 crude oil started showing tantrums and suddenly an upmove towards $70 was made .India being a country which imports more than 80% of it’s oil consumptions suddenly was caught off guard .This gave free hand to dollar speculators to play a wild move on Indian currency and even after 1-2 months of downside in Rupee RBI refused to intervene then it was all about “One way traffic” .Many people believe that it was least that RBI could have done as it was common emerging market currency sell off.But I do believe that RBI stance of it’s currency could have been more precise.Leave apart that stuff , now the grave problem that is overlooking India is a double whammy knockout from both Crude oil and Dollar rise which has literally CHECKMATED RBI!
Coming 5th October 2018 RBI would be having it’s Monetary policy review and people around the world are looking at this meeting with high expectations.Now RBI has two options for the 5th October policy review
-First option is to hike interest rates by 25-50 basis points in order to attract FII/FDI back again to the country and subsiding the Rupee downfall.But but but if RBI does so then the growth trajectory of Indian businesses will go for a toss as liquidity from the Indian monetary system would be sucked and businesses would find it difficult to grow due to higher borrowing costs moreover common households would also be spending less as spare capital in their hands would become less due to rates tightening.
Second option is not to hike rates and remain neutral .Problem with this stance of RBI is that as crude oil prices are rising sharply and we all know that all the common household items like groceries,fruits,vegetables etc. all are dependent on the transportation mediums for supply.Now as fuel prices will be high ,so will be the transportation costs and finally all this will lead to rise in the common household items price making everything costly and rising inflation.Now when inflation would rise then RBI has to anyhow rise the interest rates to cool it off .But , in the process dollar would have jumped to new higher levels making the crude oil bill overshooting to new levels and this may create a mayhem situation in India which is going into major election in 8 months of time.
All in all , I would say that RBI by not intervening in the Dollar price movement initially has landed up in a Loose-Loose situation where whatever it does with it’s monetary policy on 5th of October ,India’s economy will be facing tough crisis in coming months on all the major fundamentals .We would definitely not like Argentina ,Turkey like situation where the things have gone out of control of even their central banks.