The Hindu Business Line : A focus on price stability

THE most important feature of the RBI Review is the clear shift in emphasis in the monetary policy stance. The current policy stance clearly seeks to showcase `price stability' as the primary objective giving `provision of liquidity to meet credit growth' lesser priority vis-à-vis the July review.

The policy makes a case for containing inflationary expectations in response to the evolving scenario and for taking measures in a forward-looking manner. In line with this stance, the reverse repo and repo rates have been hiked by 25 bps, which is in line with market expectations.

The key reason for the shift in emphasis has been the acceptance by the RBI that the oil situation no longer represents a supply shock. Rather, it points to a more permanent shift in relative prices. This implies an inevitability of second order effects on inflation — which needs to be taken into account while formulating policy responses. Given this realisation, the earlier choice of tightening by allowing domestic currency to appreciate against the dollar has given way to increasing policy rates. Additionally, higher US rates and a determined Fed are the other reason for preferring the interest rate channel to the currency channel. This is also in line with actions by other central banks in the region.

Key monetary indicators all seem to suggest that the current course of policy adjustment is far from over. The RBI has placed the GDP growth at 7-7.5 per cent against 7 per cent earlier.

It has also indicated that containing inflation in the 5-5.5 per cent range would be difficult without appropriate policy responses. In terms of the other indicators, expansion in M3 is expected to be higher than the 14.5 per cent projected earlier.

Further, non-food bank credit is expected to increase significantly higher the19 per cent projected earlier.

Given all this, what is the outlook for markets in the months ahead? We expect the Fed to continue tightening possibly beyond 4.5 per cent. Further, the stance in the US is likely to move from accommodative to restrictive. Should this happen, the chances of capital flowing back to the US would increase.

This could also tighten domestic liquidity conditions and bond yields can move higher in India too. Benchmark 10-year bond yields could breach 7.25 per cent ahead of the January policy review, if underlying economic conditions follow current trends.

Introduction of intra-day short selling is a welcome measure and is possibly a prelude to allowing outright short selling in the G-Sec market in the next phase.

(The author is Managing Director, Head of Markets, JP Morgan Chase Bank.)

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