Reserve Bank of India Meeting - Governor Subbarao: Out with a whimper ::Credit Suisse

● In what will probably be Subbarao’s last meeting as Governor of
India’s central bank, all interest rates were left unchanged. This,
however, follows two intra-meeting moves designed, successfully,
to tighten liquidity conditions. Clearly, the RBI deemed these to be
sufficient for the time being.
● In fact, the Reserve Bank’s statement was surprisingly dovish,
hinting that rates would have been cut again if it hadn’t been for the
depreciation of the currency, while the tightening measures will be
unwound as and when rupee stability is deemed to have returned.
● The central bank once again urged the government to tackle
India’s current account deficit problem via structural measures. It
seems increasingly likely, however, that the deficit is being
exaggerated by an under-invoicing of export receipts and an overinvoicing of import costs. The authorities should perhaps focus on
this issue as well.
● Given the inherent unpredictability of the rupee and the prospect
of a new Governor, the outlook for policy interest rates is nothing if
not highly uncertain. At this stage, we believe the best forecast is
for an unchanged repo rate by the end of the calendar year.

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tanding pat: Having introduced two rounds of liquidity tightening
measures on 15 and 23 July, which have served to push market rates
sharply higher and brought some stability to the rupee, Subbarao’s
(probable) last meeting as RBI governor ended in a whimper rather
than a bang—all interest rates were left unchanged as had been
almost unanimously expected. We say “probable” as the government
could still choose to extend his term until after the general election.
Subbarao’s most likely successor is the pragmatic Raghuram Rajan
who is currently the chief economic advisor to the finance ministry.
A more dovish tone than expected: The guidance paragraph in the
RBI’s statement was more dovish than one might have been
expected, suggesting that if it hadn’t been for the weakness of the
currency, there was a “reasonable case for continuing on the easing
stance”. It also added that “the recent liquidity tightening
measures…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”.
At the same time, however, the central bank called on the government
to push through structural measures to address the current account
deficit with “alacrity” and suggested “it stands ready to use all
available instruments and measures at its command to respond
proactively and swiftly to any adverse development”.
Confusion reigns: It seems slightly strange for the RBI to tell the
market that it will unwind the liquidity tightening measures as and
when the currency has stabilised. After all, by indicating such an
approach, it presumably makes it less likely that stability will actually
be achieved! Above all, we suspect the wording reflects the central
bank’s tricky balancing act between its wish to support growth and its
attempt to prevent the rupee from depreciating further. In practice, the
two may well prove to be mutually exclusive and indeed it is
noticeable that the last couple of weeks have seen most forecasters
revise down their 2013/14 GDP growth forecasts once again. In fact,
the RBI itself cut its projection to 5.5% from 5.7% in today’s statement.
By way of a reminder, real GDP expanded just 5% on average in the
fiscal year ending in March 2013. We remain at the more optimistic
end of the spectrum.
External constraints: It seems to us that the underlying problem here
is the failure of the current account deficit to show a meaningful
improvement in the context of the prolonged downturn in economic
growth. This probably partly reflects structural issues, but recent
suggestions that exporters are under-invoicing and importers overinvoicing, in order boost their holdings of US dollars, have a ring of
truth about it to us. We have certainly struggled to explain India’s poor
trade position of recent times as the lagged effects of the rupee’s
weakness through the second half of 2011 and the first half of 2012
has seemingly failed to be reflected in stronger export volumes and
softer imports. Regression analysis strongly suggests something
strange is going on and perhaps the authorities need to look more
closely at this issue. It is exactly the opposite of what was happening
in China earlier this year.
What next? With the rupee inherently unpredictable and a new
Governor likely to be in place in the not too distant future, it is hard to
have any degree of confidence in India’s interest rate outlook. We
would suggest the best forecast right now is for an unchanged repo
rate between now and the end of the calendar year.