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S. Balakrishnan

It will be an easier call for Dr Reddy. A good monsoon should tame prices. The budgetary situation is likely to improve with better tax revenues on the back of the strengthening economy and disinvestment. He will be comfortable cutting the repo by another 25-50 basis points in one or two instalments.

THE baton has passed on to Dr Y.V. Reddy, who succeeded Dr Bimal Jalan as Governor of the Reserve Bank of India last Saturday.

Dr Reddy is not new to the RBI or central banking, having served earlier as Deputy Governor, when he oversaw monetary, interest and exchange rate policies. "A pair of safe hands" aptly characterises him.

One of his notable achievements in his previous stint was introducing the Liquidity Adjustment Facility (LAF), whereby surplus funds with banks could be placed with RBI at the repo rate. Similarly, the LAF enabled banks to access liquidity from the central bank, when needed. The LAF has been responsible, in no small measure, for minimising money market volatility, which was endemic in the system earlier.

Dr Reddy takes over, with the RBI coffers full of foreign exchange and growing. No crisis management imperative is here or on the economic front, with inflation falling and interest rates following suit.

The build-up of forex reserves has dramatically changed the profile of the RBI's balance sheet, with forex assets outweighing its holdings of domestic assets of mainly Government securities. The appetite of banks for the last has been so large that devolvements have become a thing of the past and new and OMO auctions have sailed through comfortably.

The first question that Dr Reddy faces is on the rupee. Should he allow the market to determine the pace of currency appreciation? His predecessor seems to have had no problem with the rupee going up, but did not want a volatile market. Given the "steady as she goes approach" that has marked his management style, it is likely that he will continue with Dr Jalan's strategy of accepting a strengthening currency as a gradual process.

Dr Reddy faces tougher issues on the monetary front. Ironically, his creature, the LAF, is seeing daily inflows of tens of thousands of crores to the RBI as the banking system is swamped with liquidity. In its absence as borrower of the last resort, short-term interest rates would have crashed. The LAF sucked money into the RBI and enabled the central bank to defend high money market rates.

Much as the situation justified a significant repo cut, rising inflation prevented Dr Jalan from acting aggressively.

It will be an easier call for Dr Reddy. A good monsoon should tame prices. The budgetary situation is likely to improve with better tax revenues on the back of the strengthening economy and disinvestment. He will be comfortable cutting the repo by another 25-50 basis points in one or two instalments.

Expect a significant drop in short-term yields in the coming weeks and months.

In the end, Dr Jalan may get what he wanted but could not in his tenure — a steeper yield curve, short rates falling faster than long.

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