A testing time for the economy

Weeks before the Reserve Bank of India (RBI)’s Monetary Policy Committee (MPC) was to meet in June, the Centre announced an excise duty cut on petrol and diesel. RBI commissioned another round of its inflation expectations survey after the cuts and it showed a downward revision of inflation expectations. This helped RBI regain some of its credibility on the inflation-management front. The excise duty cuts before the MPC meeting were evidence of the fiscal policy arm offering a helping hand to the monetary policy arm in inflation management. If the evidence of the last couple of weeks is any indication, we are also witnessing a coordination between the fiscal and monetary policy arms in managing the growing worry on the balance of payments (BOP) front. A few days after the Centre announced import duties on gold in order to discourage foreign exchange diversion, RBI followed with a range of measures to facilitate mobilisation of foreign exchange deposits from both Non-Resident Indians (NRIs) as well as institutional investors. These measures include steps such as allowing participation in short-term government debt and waiving off interest rate ceilings on NRI deposits, among others.

Why the government and RBI are doing this is not very difficult to understand. While the rupee is still a better performer when compared to other emerging market currencies — this could be more a result of aggressive RBI intervention than macroeconomic fundamentals per se — the fact that it is under pressure cannot be denied. India’s import bill has been increasing continuously on the twin tailwinds of rising commodity prices and growing demand as the economy recovers. Our exports, as the June trade numbers show, have already started moderating and could fall further as advanced countries enter a recessionary environment. India’s usual insurance of foreign portfolio investment plugging the BOP front has weakened because rising interest rates in the US and inflationary squeeze on corporate profits in the domestic economy have made the capital markets relatively unattractive. To put it simply, these are testing times for macroeconomic policy (and policy makers).

Whether or not RBI’s and government’s latest moves will prevent the rupee from falling further is not the real question. What is important is that there continues to be a healthy communication and coordination between the monetary and fiscal arms of economic policy making. The signs, as of now, are encouraging.

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