RBI has sharply tightened liquidity and pushed up interest rates to arrest the depreciation of the rupee. It may however dim hopes of reviving investment and growth. RBI has restricted the amount banks can borrow from it to 20% lower than the current level. It will carry on open market operations, selling bonds to reduce liquidity further. The corporates have gone above the repo and reverse repo corridor. Will RBI measures flush out speculative capital affecting the rupee rate or domestic bank lending which is already hit by declining investment and growth? Will it increase the lending rates of banks at an inopportune time? One may wonder if there was a need to do these. Firms that did not borrow in dollars will face higher costs. The slide in employment will continue.
Interest rates have been hiked without discussing inflation and growth expectations of the economy. It is now not just an issue of tightening monetary policy. The objective is merely to tighten liquidity. RBI has also undermined the transmission mechanism of monetary policy which has been built by it in a fragile environment. It has thus weakened its own instrument. RBI has attacked the 100 basis point corridor which enables the call rate to remain between the repo and reverse repo rates. The finance minister is asking banks to curtail their lending rates. RBI is doing just the opposite. The impact of RBI policy on growth and investment will no doubt be adverse. This is not the first time that RBI and the finance ministry are working at cross-purposes.
