The Hindu Business Line : Bullish on growth, hawkish on inflation

The RBI's underlying policy message is clear — inflation is its primary concern and gets priority over other objectives such as growth and investments.

THE RBI Review turned out bullish on growth but more hawkish on inflation than was expected. Thus, while the central bank revised the GDP growth forecasts up from 7 per cent to 7-7.5 per cent, the underlying policy message is clear — inflation is its primary concern and gets priority over other objectives such as growth and investments.

Thus, the RBI chose to hike the repo and reverse repo rates by a quarter of a percentage point to curb liquidity. In doing so, the apex bank has followed the precedent set by the US Fed and other Asian central banks that recently raised their key policy rates. The RBI's specific apprehensions pertain to a further rise global oil prices and the `second order' effects of the recent domestic oil price hike. The latter, in lay terms, is simply the pass-through of increased fuel and freight costs of producer on to consumers. This typically happens in an environment where economic growth is strong and liquidity ample.

To quote the policy, "given the outlook for inflation in the context of the oil economy in India, it may be difficult to contain inflation in the 5-5.5 range without an appropriate policy response." Hence the hike in repo rates.

Liquidity is already under pressure due to a combination of strong credit demand and reduced inflow of external capital. The repatriation of the `Indian Millennium Deposits' at the end of the year will entail a further draft on domestic liquidity, at least temporarily. Given this, the policy rate hikes are bound to translate into a moderate rise in borrowing and lending rates. The increase in the general provisioning requirement for `standard' loans from 0.25 per cent to 0.40 per cent will strengthen the case for lending rates.

However, a severe shortage of liquidity and a sharp spike in interest rates seems unlikely. There are mechanisms such as the Monetary Stabilisation Scheme (MSS) by which the central bank can infuse liquidity. The policy affirms that the RBI is committed to `provide appropriate liquidity consistent to meet genuine credit needs.'

The RBI appears to be more sanguine on the external front. In its assessment, the invisible earnings form exports of items such as software make the large trade deficit that comes on the back of robust oil imports somewhat manageable. However, it does emphasise the fact that the balance of payments warrants careful monitoring and it is likely that another round of sharp depreciation of the currency in the market would invite corrective action from the RBI.

Some institutional changes have also been announced. The move to introduce intra-day short selling in gilts may be one of the first steps in reviving what has been a moribund market.

The RBI had introduced the theme of `inclusive banking ' in the previous policy and it now makes operational this philosophy in this policy by directing banks to make a basic `no frills' account available to customers either with `nil or 'minimum' balances and nominal charges.

(The author is Executive Vice-President and Country Representative - India, ABN AMRO Bank.)

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page