Reddy Gets The First Call To Decide On Rate

MUMBAI: Hours after RBI governor YV Reddy comes out with his mid-term policy review on October 30, the federal open market committee (FOMC) will meet to decide on interest rates in the US. Market participants may, therefore, hesitate to take a view either on the exchange rate or interest rates, immediately after Reddy announces his policy.

While this is not the first time that the meeting of the two policymakers has coincided, this time all eyes are on the Fed, which is widely expected to announce some more rate measures. The Fed meeting earlier this month resulted in a rate cut that sent markets rallying worldwide and the dollar slipping to a new low.

The challenge for Reddy would be to take a call on global capital flows without knowing whether the Fed will cut rates once again or not. A second rate cut would further widen the gap between interest rates in India and in the US. A rate cut would also put upward pressure on the rupee as global funds would exit dollar debt and seek better returns in emerging markets.

HDFC Bank chief economist Abheek Barua points out: “The RBI governor is not constrained to make all announcements on the day of the policy itself. He could well wait for the Fed to announce its decision and then, in the event of a rate cut in the US, announce a cut in the repo rate in November or December.” He further added that the one key challenge before Dr Reddy would be to manage the huge inflows entering into the country, and this could be regardless of whether the Fed cuts rates further or not.

The inflows from FIIs into India got accelerated after the Federal Reserve cut rates by 50 basis points last week. This saw the rupee breach the 40-mark versus the greenback after a long span of nine years.

A rising rupee spells doom for exporters and hence, calls for active intervention from the central bank so that export competitiveness remains protected. Spells of continuous intervention will in turn increase the cash flows in the banking system and this could see inflation rearing its head once again. Thus to tackle the anticipated liquidity issue, RBI could look at either hiking the cash reserve ratio (CRR) or else, resort to issuing bonds under the market stabilisation route.

ICICI Bank chief economist Samiran Chakraborty explained, “RBI is more likely to take a decision, based on the 50-bps cut which the Fed has already announced. At the current juncture, the central bank may not go in for a cut in rates, as it would prefer to wait for further action from the Fed. Even though current inflation numbers are benign, rising oil and food prices will raise inflationary concerns