F ACED with headwinds caused by geopolitical tensions, prediction of a below normal monsoon, and consistent outflow of foreign funds from Indian markets, the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) has adopted a cautionary stance by holding interest rates at 5.25 per cent and taking some good measures to send a positive message to the country. In these times of uncertainty due to global pressures, the RBI has chosen pragmatism over a miscalculated adventure. This is the first time since he took over as Governor of the central bank that Mr. Sanjay Malhotra has sounded a bit cautious in his commentary. He was very guarded in messaging the country that the fear of inflation remains a reality due to various factors and growth can come but not at the same pace clocked before the beginning of the West Asia crisis. The threats are right in the face and the RBI had no option than to be on guard before moving to any drastic measure in the near future. Elevated energy prices and disruption in global supply chains were the major factors that the MPC had to consider for a hike in interest rate. Though the markets had factored in a status quo in repo rate due to the prevailing situation, there was a belief that the RBI might take the rate-increase route followed by central banks of many major economies.

 

Given the fluid situation in the country due to shortage of oil and gas supplies, a rate hike could have sharply jacked up inflation fears. The RBI has moved well by keeping the fears locked until it finds a way out to mitigate the crisis. More than the repo rate pause, it is the commentary by the RBI Governor which holds big significance for the markets and consumers. There was a major effort to plug the gap in the money markets caused due to large-scale exodus of foreign investors in the first half of the year. Foreign Institution Investors (FII) have taken out massive funds from Indian stocks over the fears of a huge disruption caused partly by the subdued results of top companies and majorly due to the impending energy crisis affecting almost all domestic sectors. Parking money in Indian stocks and bonds and paying more in the form of taxes was clearly rejected by foreign investors. The RBI and the government have done really well to address the problem quickly and project India as a healthy investment destination.

 

By exempting foreign investors from income tax of interest earnings and capital gains from Government Securities, the government has sent a positive message to FIIs. G-Secs are a favoured instrument of investment for many NRIs and FIIs. However, it was losing sheen due to the high short term and long term capital gain taxes and parking fee. FIIs were finding the 12.5 per cent LTCG and 30% STCG too high on Government Securities and started exploring other markets with lower tax rates. It was a negative sign for Indian indices as the FII outflow started severely impacting markets. It turned into a double whammy when the West Asia crisis started. The Indian markets have been going through tremendous volatility in the last three months. The government has shown timely concern to address this issue by scrapping taxes for foreign investors. It now needs to stay cautious on the inflation front too, as much will depend upon how India’s farm sector performs if the monsoon disappoints.