| RBI’S Quarterly Review of Monetary Policy |
The RBI Governor, Dr Y.V. Reddy, has been justified in keeping interest rates and other monetary policy measures unchanged, keeping in view the inflationary threat inherent in the oil and food price scenario. All in all, a review that scores on masterly inaction, comments S. VENKITARAMANAN
The RBI’s monetary policy statements are keenly awaited. They are key pointers that determine bankers’ lending rates and how much they are willing to provide by way of credit. These monetary indicators are determined on the basis of the central bank’s reading of macro-economic conditions, the latest exercise on which preceded today’s announcement. While Governors have been known to surprise and shock at times, the RBI Governor, Dr Y.V. Reddy, has th is time surprised us by masterly inaction in the face of contrary expectations that he would cut rates or the CRR, or both.
Dr Reddy’s third-quarter review of the annual statement of monetary policy has surprised some and pleased many in the market.
The recent Bush-Bernanke initiative had led to expectations that Dr Reddy would do his bit by reducing interest rates on the lines of the US Federal Reserve. He has made a point of not doing so, emphasising the difference between conditions in India and the US.
For one thing, the Indian rate of growth, though moderate, remains robust. There is no perceived threat of recession in India at present. Demand conditions, except in parts of the consumer durables sector and segments of the auto industry, are robust and perhaps Dr Reddy is justified in his “no-change” stance in the light of India’s overall situation.
The markets have, however, expected a reduction in interest rate, but this was partly a psychological factor that flowed from the argument that “When the Fed can do it, why not the RBI? That seems to be a question Dr Reddy has answered.
Inflation threat
Dr Reddy has, however, been justified in keeping the interest rates as well as other monetary policy measures unchanged, keeping in view the inflationary threat potentially inherent in the oil prices and food prices scenario.
He does not also perceive a recessionary threat. Inflation management, rather than growth per se, seems to be the Governor’s primary objective.
From the point of view of reducing capital flows, the argument was that the Governor must have been sorely tempted to reduce the rates of interest, at least in respect of repo rate and reverse repo rate, in view of the Fed’s reduction of 75 basis points.
He must have been persuaded against this because of the fact that the flows of capital by borrowing from abroad have already been contained by administrative action, in the form of limits on external commercial borrowing. This is not ideologically pure, but does serve the purpose of reducing capital inflows.
Further, the capital flows on the portfolio front are not very sensitive to interest rate differentials but are dictated by asset prices. In this context, the Governor’s policy of watchful waiting may well pay rich dividends.
This is especially apposite in view of the political situation, which dictates that the coming Budget may well be motivated by the looming electoral battle and inclined to be more populist than otherwise, effectively releasing inflationary pressures.
Advice to banks
So far as banks are concerned, Dr Reddy has given advice that they should look towards reducing lending rates, especially to sectors that are employment-intensive.
Perhaps, this flows from Finance Minister’s exhortations to bank Chief Executives to reduce lending rates. Whether the Governor’s exhortations will succeed is a tricky question. To what extent the banks will be able to do this, even given what Governor calls the comfortable liquidity conditions, depends very much on the demand and supply conditions in the credit and deposit market.
The Governor has been quite clear in his declaration of intentions to unleash further action in the event of unfavourable development, either domestically or internationally. This is a warning that April 2008 policy statement might very well see either a rate increase or cash reserve ratio increase, depending on the inflationary pressures at the time.
Till then, we can only hope that OPEC will continue to be benevolent and that the farm sector will behave better so that inflationary pressures will be contained other than by monetary action.
Not a catch-up game
By and large, Governor’s latest monetary initiatives or lack of them involve a deliberate policy of masterly inactivity, Governor Reddy has not yielded to the temptation of playing up with the international peers, like Bernanke. In the event, this policy may turn out to be the best contribution of Dr Reddy in his term.
Turning to the perennial issue of the appreciating rupee, the Governor has managed to keep the exchange rate policy unchanged, perhaps emboldened by the growth of currency-sensitive services exports, such as software and other services sector activities in spite of the appreciating currency. Surely, when circumstances change, the Governor has promised that he will be ready with an appropriate response.
All in all, the credit policy that may not call for a celebration of boldness, but still deserves cheers for not rocking the boat! Thank God for the Governor’s mercies for the present.
