Waiting for Godot is a play by the noted Playwright Samuel Becket. The essence of the play is that two characters wait endlessly in vain for a person named Godot to arrive, and the person never arrives.
RBI is waiting for the Indian Rupee (INR) to stabilize to act on growth but the fact is that the wait can be endless. The INR has depreciated by over 25% over the last couple of years on the back of many factors including fiscal and current account deficits, rising inflation and falling GDP growth, strength in the US economy relative to the rest of the world and expectations of the US Federal Reserve (Fed) withdrawing its asset purchase program sooner than later.
The central bank, in its first quarter 2013-14 policy review, has lowered GDP growth forecast for the Indian economy for fiscal 2013-14 to 5.5% from 5.7% and has brought down its March 2014 inflation target from 5.5% to 5%. RBI would normally have continued to ease monetary policy in response to lower growth and falling inflation expectations but the INR has played spoilsport to the easing move by falling to record lows against the USD in the first week of July 2013.
RBI instead to easing policy rates of repo that was lowered by 125bps since April 2012, has tightened liquidity conditions to prevent excessive speculation on the INR. RBI’s actions have had a huge negative impact on the bond markets with bond yields rising by 50 to 75 bps across the curve and money market rates rising by 300bps.
Rising interest rates in the economy further delays economic recovery and if the economy falters it places further pressure on the INR, as there is a very strong correlation to growth and INR strength in India. The fact that the country’s current account deficit is financed by capital flows that in turn reflects growth expectations of the economy makes growth extremely important for the INR stability.
RBI has stated that it will reverse its liquidity tightening measures and continue on its easing policy stance once the INR stabilizes. However the fact is that INR stability is not in RBI’s hands as admitted by the central bank in its first quarter 2013-14 macro economic and monetary developments review. RBI can only temporarily lend support to the INR and for the long term it is up to various other factors including lowering the CAD through structural reforms.
In the immediate future markets will watch for any volatility in the INR for direction. The INR is fortunately being helped by signs of global markets stabilizing with the Fed underlining its commitment to support the US labour market with low interest rates. The currency is trading at levels of Rs 59.84, up from lows of over Rs 61 but also down from highs of Rs 59 and below seen last week. The INR is likely to take direction for the Fed’s policy meet this week.
India’s structural issues are not going to be addressed overnight. Global markets will move to the Fed’s tunes. RBI will be waiting for the INR to stabilize before acting to support growth. How long for the INR to stabilize? Hopefully it is not Godot!!