Key Takeaway
RBI's policy is a radical shift with little back-down option for a while. It
eliminates new policy drives with a new governor. The currency line in sand
would likely be tested multiple times; at each point, risks of either unforeseen
monetary activism and/or failure would keep markets nervous. We downgrade
financials to UW and increase weights for defensives (staples) and exporters
(IT), in anticipation of more export-friendly policies.
The RBI says it perfectly:
“India is currently caught in a classic ‘impossible trinity’ trilemma, whereby we are having to
forfeit some monetary policy discretion to address external sector concerns”.
We do not remember a time when explicit RBI policy priority order was currency stability
first, inflation second and growth third. Unlike the desire to see current account (CAD)
stability or balance of payment improvement (BOP), the currency defence, though, is a daily
affair.
Current policy not a short-term affair - We absolutely understand when the central
bank says that:
“The recent liquidity tightening measures by the Reserve Bank are aimed at checking undue
volatility in the foreign exchange market and will be rolled back in a calibrated manner as
stability is restored to the foreign exchange market, enabling monetary policy to revert to
supporting growth with continuing vigil on inflation”.
However, we believe the above statement is a wishful dream as things stand today. We do
not discount the possibility of the INR stabilising for a few weeks once the government
announces some trade or investment measures. But no trade or investment measures could
stabilize the BOP so comprehensively that the INR turns as stable as before in a quick time.
More likely than not, we believe the currency volatility – or the fears of it and associated
policy tightening – will return with every unforeseen events in domestic politics, economy
or global financial markets in the next 12 months to come. As a result, we do not expect
the market to begin expecting pro-growth benign central bank policy for at least until the
elections.
What next?
“It should be emphasised that the time available now should be used with alacrity to institute
structural measures to bring the CAD down to sustainable levels”.
The RBI policy statement calls for the government to implement structural reforms to bring
down CAD. While re-emphasising the point we made last year that the CAD corrections are
extremely painful and happen only over an extended period of time, the time has come to
consider the next policy moves. In coming months, fiscal policy activism should resurface
with the following likely announcements:.
1) Trade reform 1: anti-imports.
2) NRI bond issuance.
3) FDI related announcements.
4) Trade reform 2: pro-exports.
5) Pro domestic investment announcements to cheer the local business confidence.
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RBI's policy is a radical shift with little back-down option for a while. It
eliminates new policy drives with a new governor. The currency line in sand
would likely be tested multiple times; at each point, risks of either unforeseen
monetary activism and/or failure would keep markets nervous. We downgrade
financials to UW and increase weights for defensives (staples) and exporters
(IT), in anticipation of more export-friendly policies.
The RBI says it perfectly:
“India is currently caught in a classic ‘impossible trinity’ trilemma, whereby we are having to
forfeit some monetary policy discretion to address external sector concerns”.
We do not remember a time when explicit RBI policy priority order was currency stability
first, inflation second and growth third. Unlike the desire to see current account (CAD)
stability or balance of payment improvement (BOP), the currency defence, though, is a daily
affair.
Current policy not a short-term affair - We absolutely understand when the central
bank says that:
“The recent liquidity tightening measures by the Reserve Bank are aimed at checking undue
volatility in the foreign exchange market and will be rolled back in a calibrated manner as
stability is restored to the foreign exchange market, enabling monetary policy to revert to
supporting growth with continuing vigil on inflation”.
However, we believe the above statement is a wishful dream as things stand today. We do
not discount the possibility of the INR stabilising for a few weeks once the government
announces some trade or investment measures. But no trade or investment measures could
stabilize the BOP so comprehensively that the INR turns as stable as before in a quick time.
More likely than not, we believe the currency volatility – or the fears of it and associated
policy tightening – will return with every unforeseen events in domestic politics, economy
or global financial markets in the next 12 months to come. As a result, we do not expect
the market to begin expecting pro-growth benign central bank policy for at least until the
elections.
What next?
“It should be emphasised that the time available now should be used with alacrity to institute
structural measures to bring the CAD down to sustainable levels”.
The RBI policy statement calls for the government to implement structural reforms to bring
down CAD. While re-emphasising the point we made last year that the CAD corrections are
extremely painful and happen only over an extended period of time, the time has come to
consider the next policy moves. In coming months, fiscal policy activism should resurface
with the following likely announcements:.
1) Trade reform 1: anti-imports.
2) NRI bond issuance.
3) FDI related announcements.
4) Trade reform 2: pro-exports.
5) Pro domestic investment announcements to cheer the local business confidence.
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