The sharp depreciation of the rupee over the last ten days has provided enough excuse to the Reserve Bank for yet another round of measures designed to strengthen the rupee. The question is the price which the economy will have to pay for keeping the rupee stable.It is to be hoped that the price will be relatively low, a hope which rests on the inflow of Resurgent India bonds, on the one hand, and the general feeling that there is plenty of liquidity. That feeling is based on the above-target growth in money supply and bank deposits; the lack of credit demand; and the fact that this is the slack season.
The Reserve Bank has also done its bit to keep liquidity in abundance, mainly by large doses of monetisation. But call rates have remained over 7 per cent this entire week, although that was probably due to banks funding dollar positions through the call market. September could see a further tightening, with advance tax outflows and the start of the busy season.
Monetisation is already high, and although it has been pursued as a conscious policy, further resort to it is fraught with dangers. Inflation is no longer benign. Nevertheless, in the absence of a pick-up in the economy, liquidity is expected to remain adequate over the medium-term.
The risk is that the knee-jerk reaction may send interest rates spinning out of control, as had happened in January. But the RBI has wisely allowed some time before the CRR cuts take effect, learning from its January experience, when call rates shot up beyond 100 per cent. This should allow time for cooling things down. The weight of opinion seems to be that although interest rates will rise, they will eventually settle down. Till the next time the rupee comes under pressure.
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