INR and RBI –History repeating itself?
The Reserve Bank of India (RBI) delivered a surprise 200bp hike in the Marginal
Standing Facility (MSF) earlier this week, along with capping banks’ repo borrowing to
INR750bn and the announcement of the absorption of market liquidity through the
open market sale of government securities. The RBI’s moves were targeted to push
short-term interest rates sharply higher, thereby, making forex speculation costlier. A
similar strategy was adopted by the RBI in January 1998, immediately after the South
East Asian currency crisis in November 1997, to combat heightened forex market
volatility. We spot a few key comparisons between the RBI’s current moves vis-à-vis
those in early 1998.
Tightening in 1998 –Adeparture from the RBI’s stated easing bias
First, the RBI had been easing in the recent months despite their cautious rhetoric (75bp
repo rate cuts from January to April2013). The current hike can, thus, be seen as a departure
from the course of RBI action, albeit possibly on a temporary basis/in the near term.
Similarly, during late 1997, the central bank had clearly started monetary policy easing to
revitalise growth following a phase of high inflation, heavy monetary tightening and a slump
in growth during the mid-1990s. In fact, in October 1997, the RBI had explicitly guided for
the lowering of the cash reserve ratio (CRR) cumulatively in stages, to 8% from 10%, on
eight specified dates between October 1997 and March 1998. Thus, on both occasions,
while the domestic macroeconomic considerations prompted the RBI to remain growth
supportive, the meaningful deterioration in the macroeconomic backdrop got triggered
from external developments (the Asian crisis in late 1997 and the current possibility of QE
tapering), whichled to a quick switch in policy priorities of the central bank.
Tightening in 1998 was multi-layered, fast and furious
Second, the quantum of hikes in policy interest rates and/or in reserve requirement
(CRR) had been stark on both occasions. Similar to the hike in the MSF rate earlier this
week, the bank rate was hiked by 200bp on 16 January 1998 (to 11% from 9%).
Additionally, CRR was hiked by 50bp to 10.5% and the repo rate was raised by 200bp to
9% at the same time. Currently also, the measures relating to restricting banks’ repo
borrowing quantum and the announcement of the sale of government securities
through open market operations (OMO) highlight the focus on tightening liquidity by
the RBIto make hikes in policy interest rates more effective.
Third, bank rate –which was the key policy interest rate in the late-1990s –was hiked in
January 1998. Hiking the key policy interest rate was not the first step from the central
bank. Prior to that, the RBI had hiked the repo rate (which was an additional policy
interest rate during that time) sharply from 4.5% to 7% in three stages within a span of
less than 10 days (3-11 December 1997). It was, in fact, hiked again by another 200bp
to 9% on 16 January 1998. In the current phase, the RBI has so far not hiked the repo
rate – which is the key policy interest rate in the RBI’s current monetary policy
framework. It is important to note that we do not expect any hike in the repo rate in the
current round. Such a move would not necessarily enhance the probability of effectively
curbing pressures on the INR, in our view, since it could further dent FII flows into India
