Whenever RBI takes hold of the situation, it does it in such a way that not only surprises the market but the finance pundits too.
No one expected the central bank to react to the problem (continuously depreciating rupee) in such a way as it did some days back. The bank was in a dilemma whether to go for rate cuts to fuel the much needed growth in the economy or cut down on the sources of liquidity to enable the rupee emerge stronger in comparison to the dollar.
The bank responded smartly and considered the second option to the first. RBI capped the daily borrowing from the repo window to Rs75,000 crore that amounts to 1% of the deposits.
Thereon, it increased the interest rate on the marginal standing facility (MSF) by 200 points, though it’s already 100 basis points higher than the repo rate (7.25%) and stood at 8.25 previously. Now it’s increased to 10.25 — a 2% increase. The repo rate has remained unchanged.
Furthermore, in order to suck up the liquidity in the market, the central bank has announced to sell the government securities through the open market route. Therefore, RBI has cleared its view before its next meeting which is scheduled at the end of the month, which it wants to plug all the sources of liquidity in the market at the earliest to impart some strength to the constantly falling rupee, by limiting its supply in the market.
At least, this puts an end to the discussion regarding cut in the interest rates. RBI is in no mood to give on the request by the industry to lower the rates so that the sluggish economy achieves some growth.
With this masterstroke by RBI, urgently needed inflow of foreign currency (much needed) is possible in the times to come. This can happen through higher investment in domestic debt by foreign institutional investors.
The money will be drawn towards debt funds but equities will take a hit as a result. Something for sure, banks will be more cautious in lending from now on amidst tight control and have to work towards conserving as much liquidity as possible.
The credit growth has dwindled substantially for the past few months and the recent decision will put more pressure on the credit outlay. However, a little compromise today can result in large gains tomorrow.