Global central bankers really need to work on their "clear" communication skills: first, the Fed shocked everyone by not tapering on Wednesday, and now, in his first decision since taking over the reins of the Reserve Bank of India, its new head Raghuram Rajan, stunned the world even more, and all 36 analysts who predicted an unchanged decision by the central bank, with the first hike of the country's repurchase rate since 2011, by 25 bps to 7.5% in an attempt to rein in inflation. And just to keep the confusion to a maximum, the RBI also piled on the stunners by concurrently pursuing various other policies that contradicted the repo rate hike, and directly seek to inject even more liquidity into the market, thus offsetting any inflation-battling measures.
"Stunned" because as readers will recall it was a month ago [6]that the Rupee was crashing, economic growth was imploding, local markets were undergoing cardiac arrest, and reserve outflows were threatening the stability of the entire Indian financial system, which forced the central bank to step in with various liquidity boosting steps. Further recall that it was a month ago [7]that the world was lamenting the flip-flopping of the RBI, which justified its contradictory actions at the time by saying "It is important to address the risks to macroeconomic stability . . . At the same time, it is also important to ensure that the liquidity tightening does not harden longer term yields sharply and adversely impact the flow of credit to the productive sectors of the economy."
The problem as CLSA's Rajiv Malik summarized best is that "they still appear unsure of what [growth, rupee, bonds] they want to eventually save." Today, the action was focused on inflation, and the rupee, because unlike in the west, India does have a very insidious case of persistent inflation which is taking place even though the financial system is locking up due to lack of liquidity. Oh what to do.
And just to keep the confusion to a maximum, and to send dovish signals, the RBI concurrently reduced its marginal standing facility rate by 75 bps to 9.50%. Like in Europe, the marginal standing facility is an emergency funding facility for banks, which was increasingly being used since the summer. Additional liquidity boosting steps involved the relaxation of rules on the cash reserve ratio, which is the percentage of deposits that banks must hold as cash with the central bank. The central bank said banks would have to maintain cash equivalent to 95% of the CRR through the reporting two weeks, from 99.0% earlier. The CRR currently stands at 4.0%.
[8]
The Repo rate is at 7.50% with a 25 bps hike, first hike since October 2011
Even Goldman was shocked:
The decision to hike the repo rate was a surprise (all 36 economists polled by Bloomberg expected no change). The RBI mentioned that WPI inflation will be higher than initially projected for the rest of the year. It also sounded alarm at the high level of retail inflation. It mentioned that the CPI has been high for a number of years, entrenching inflation expectations at elevated levels, and eroding consumer and business confidence.
In our view, the RBI has risked sending a confused signal to markets, and the withdrawal of tightening measures may be premature. It has eased liquidity tightening measures but raised repo rates to address inflationary pressures to provide a stable nominal anchor for the economy. The RBI has made future action on reducing the MSF rate dependent on exchange market stability, but raised expectations that it would gradually withdraw them.
The bottom line as the WSJ summarizes [9], is that "while India's economy is growing at its slowest pace in a decade, inflation has gained pace in recent months as the rupee's decline has made imports more expensive."
And sadly India's central bank is now sending even more confused signals than before: is it easing or is it tightening? Because as much as it would like to fine tune its shotgun policy, it will fail miserably at both if it can't figure out which is dominant. As a result the Sensex predictably tumbled by nearly 2% overnight as markets are once again confused whether to buy or sell.
One thing is certain: look for the RBI and the government, to scapegoat gold even more, and pursue even more aggressive capital control measures to limit the conversion of paper into gold, which instead will merely accelerate the population's attempt to preserve what is left of their purchasing power in the form of shirts made out of "barbaric relics" and other such hard asset conversions.