By playing along with the government, the RBI risks sending a, perhaps, unwarranted signal: that it is happy to play ball regardless of whether, in the process, it risks taking its eye off its main goal - price stability.
The Reserve Bank of India (RBI) might argue that the 50 basis points reduction in the marginal standing facility rate announced late Monday as well as seven and fourteen day repos are aimed at signalling a return to 'normalcy'. Also, that the move is in keeping with the governor's promise to make the repo, rather than the MSF rate, the main signalling rate so that it is the MSF rather than the repo that has to do the 'walking'. Except that both arguments sound a bit contrived!
After all, it is just over a fortnight ago that the Bank in its wisdom thought it fit to reduce the MSF by 75 basis points, rather than go in for a more aggressive easing on the grounds that consumer price inflation is still high and savings in financial instruments is less than desirable. Has anything changed on either of these two fronts? No!
What has changed is that the rupee seems to have stabilised (temporarily/riding on the breather given by the US Fed deferring its tapering?). What has also changed is that there are indications that the current account deficit (CAD) for the second quarter will be substantially lower thanks to lower gold imports (through legal channels) and better export performance riding on the cheaper rupee. But then the rupee had largely stabilised at the time of the mid-quarter review on 20 September. And it was common knowledge that second quarter CAD would be substantially better than in the first quarter.
So I come back to re-stating my first contention: that the RBI's action on Monday does not quite gel; it does not fit in with the inflation-fighting zeal shown by Rajan both in his mid-quarter review and subsequent comments. Instead of sending a strong signal to banks that they must fund their asset portfolio through deposits rather than borrowing from the RBI by keeping MSF rate as a penal rate, the RBI has done the opposite.
MSF, as the name suggests, is a 'marginal' facility, a facility extended at the margin for banks to tide over temporary liquidity mis-matches. When these mis-matches are so persistent and on such a large-scale that they are seen as 'determining' interest rates there is clearly a structural problem and the RBI needs to address that rather than play along.
But by playing along the RBI risks sending another, perhaps, unwarranted signal: that it is happy to play ball with the government regardless of whether, in the process, it risks taking its eye off its main goal - price stability. Low and steady inflation is both the best elixir to growth and the best antidote to poverty.
MSF cut: RBI weakens its inflation-fighting credentials
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