Bibtex
Endnote
RIS
It is by now well recognised that geopolitical risks combined with impulsive and non-uniform drifts of a dominant economy like the United States in trade and other economic policies have contributed to considerable economic uncertainties in policymaking in much of the globe. India in particular has been the main target of such policy drifts, at least so far.
Since there will be improvement in the liquidity, there will not be any need for reduction of the policy rate
This has necessitated economic policy makers in India to undertake measures that reduce the perceived adverse impact of the uncertainties with least economic cost even if this meant a deviation from the generally accepted theoretical line of thinking. Here we shall point out two instances to highlight the point that the received economic theory has been strained in the attempts to address economic uncertainties faced by countries like India.
The first policy deviation from the theoretical frame pertains to the sharp depreciation of the Indian rupee vis-à-vis the US dollar despite the generally sound economic fundamentals in place. The general tendency on the part of a policy maker is that a depreciation of the domestic currency against the US dollar, by more than two to two-and-a-half percentage points over a given time horizon would need to be addressed by the central bank intervening in the foreign exchange market. The Reserve Bank of India (RBI) in fact intervened initially but with no avail. In fact, such interventions have only resulted in reduction of foreign exchange reserves.
The RBI has already indicated that it would likely inject about Rs 2 lakh crore liquidity through open market operations, foreign exchange swaps and variable rate repo operations
Simultaneously, there occurred foreign capital outflows for reasons that are not fully justifiable on grounds of economic logic. And when the rupee depreciation was of the order of four percentage points, policy makers discarded the logic of market intervention. They in fact felt that India need not bother about the extent of current depreciation because it will help improve India’s exports. However, depreciation would hurt importers.
Is there an unspecified limit to rupee depreciation against the US dollar?
In the case of India, the demand for imports, in an atmosphere of the given aspirational goal of eight per cent growth and the need for defence capability for purposes of national security, is generally inelastic, particularly so in respect of oil and critical minerals such as the rare earths. The balance of trade would, therefore, not be very different from the trend of the recent past. The said analysts’ justification, however, is based on the argument that India’s economic fundamentals are sound and do not require the RBI to intervene in the foreign exchange market at high cost.
Is this an exceptional policy move to meet unusual circumstances? Would the policy move hold good if the rupee depreciated even further? Is there an unspecified limit to rupee depreciation against the US dollar?
The demand for imports, in an atmosphere of the given aspirational goal of eight per cent growth and the need for defence capability for purposes of national security, is generally inelastic, particularly so in respect of oil and critical minerals such as the rare earths
Take another case of the fiscal position created by the sharp reduction in the inflation rate below the lower end of the inflation target range of two per cent under the inflation targeting framework. A two per cent inflation rate will mean a lower nominal GDP growth than the required 11 per cent and higher for fiscal receipts to be optimal.
If the real growth is around seven per cent as at present, a nominal growth of nine per cent will mean a dent in fiscal receipts and this would, given the public expenditure programme, imply a rise in the fiscal deficit. The implications of such a development are that the government will have to raise receipts through changes in the rates of the existing taxes or imposition of new taxes and/or reduce the budgeted expenditures. In the short run, neither of these options is feasible.
Liquidity in the busy seasons would be tight as it appears to be the case now
Under such circumstances, the monetary policy would need to be circumspect in respect of the liquidity surge or lowering of the policy rate. Liquidity in the busy seasons would be tight as it appears to be the case now. The RBI has already indicated that it would likely inject about Rs 2 lakh crore liquidity through open market operations, foreign exchange swaps and variable rate repo operations.
Markets however seek a larger injection of liquidity of over Rs 3 lakh crore. Since there will be improvement in the liquidity, there will not be any need for reduction of the policy rate. It would be a surprise if the RBI reduces the policy rate even by a token amount of 15-20 basis points without being rigid about the policy stance in the next two months. Such an action would not be in sync with the received theoretical view of fiscal-monetary policy coordination.
