The Hindu Business Line : RBI restrains to surprise

The expectation had been that the RBI would be `tough-minded' and tighten the policy a little bit more. The very fact that Dr Y. V. Reddy has not done so and kept the policy rates unaltered, including some bows in the direction of external rate liberalisation, shows that he is responsive to the point of view that growth is important, says S. VENKITARAMANAN.

The market has reacted to the Reserve Bank of India Governor, Dr Y. V. Reddy's latest Monetary Policy with an expected response of vote of confidence, leading to a rise in the Sensex. Perhaps, the market reacted prematurely without taking into account Dr Reddy's further intentions. But it is a fact that the Governor has, in a way, continued his policy of delivering surprises by limiting his restrictive steps. The expectations of the market had been that the Governor would be `tough-minded' and tighten the policy a little bit more. The very fact that he has not done so and has kept the policy rates unaltered, including some bows in the direction of external rate liberalisation, shows that he is responsive to the point of view that growth is important. In fact, he has surprised the markets by his moderation.

Dr Reddy has adequately stressed the fact that the country's financial system has become more mature and in particular the foreign exchange market has become less volatile and economic growth seems to be on a self-sustaining track. There are no indications in the Monetary Policy statement of attempts to control the growth of credit in specific sectors, such as those which occurred in the last Policy. The main merit of the Governor's latest policy statement is that he recognises both the limits and the strengths of monetary policy actions in controlling inflation in a developing economy in a globalising world. At the same time, he also recognises that too little monetary action may expose him to criticism that the RBI did not act in time against inflation.

Policy rates unchanged

The monetary measures announced by the Governor indicate, in the main, that the Bank Rate has been kept unchanged at 6 per cent, the reverse repo and repo rates remain unchanged at 6 per cent and 7.75 per cent respectively. The RBI retains option to conduct the overnight repo or longer-term repo rates under the Liquidity Adjustment Facility depending on actual market conditions and other relevant factors. On Cash Reserve Ratio, the Governor has decided to keep the ratio at 6.5 per cent with effect from April 28. He has reduced the rate of interest on FCNR deposits to impact the inflows under this head and thus to reduce pressure on liquidity. In a telling passage in the policy statement, Dr Reddy points out that the Monetary Policy in India has to contend with the burden of challenges emanating from various sectors. It has to be recognised first that the Monetary Policy is to bear the burden of fiscal demands.

Fiscal imbalances remain large by international standards and have to be managed in a non-disruptive manner keeping in view the interaction of financial markets and the real economy as well as the given legal, institutional and public policy environments. In short, the Governor's implicit plea is for the fiscal imbalance to be reduced. He, however, recognises the recent salutary improvement in the fiscal position of the State as well as the Centre.

Obscuring signals

The Governor recalls the several complexities governing conduct of Monetary Policy in the current juncture. Globalisation has brought in its trail considerable fuzziness in reading macroeconomic and financial development obscuring signals from the financial prices and clouding the monetary authorities' assessment of the performance of the real economy. Translated into common language, what the Governor means is that the central bankers find it difficult to understand what happens in the real world given the confusing concatenation of aggregates.

Further, he makes an important observation that dealing with the impossible trinity of fixed exchange rate and open capital account, discretion in monetary policy has become more complex than before.

He also recognises that there is considerable difficulty faced by the monetary authorities of the world in detecting and measuring inflation, especially inflationary expectations. In short, this is a central banker's confession of the difficulties faced in making monetary policy centred on inflation management in a world open to capital flows.

It is good therefore that Mr Reddy has decided to be benign instead of forcing a partially wrong diagnosis on the Indian economy, poised as it is, on the edge of rapid growth.

Critical Variable

Dr Reddy has set himself a target of 4.5 per cent inflation. The Finance Minister implicitly said in an interview following the Credit Policy that this is an aggressive target. But I hope that the Governor will continue to be sensitive to the demands of growth, for which credit availability is a critical variable for growth.

The point to note, as some observers have mentioned, is that the Governor has retained the freedom to intervene at any future point in case he finds inflationary trend persists and related bottlenecks arise. That is the central banker's privilege.

Sufficient for the day it is that the Governor has stayed his hand to let the market behave and the economy grow according to its best impulses. He has not restricted the rate of growth of credit. In fact, he has liberalised some of the regulations regarding foreign exchange outgoes, which is perhaps his way of meeting the challenge posed by the inexhaustible inflows.

Dr Reddy has credible and creditable record in managing the economy. He has kept the level of credit growth reasonable and in keeping with the demands of the real economy. Foreign Exchange markets have been stable and there has been no volatility in the financial markets or in the capital market. He has also got in a series of measures to systematically improve the working of the financial sector and its regulation.

The latest Monetary Policy is an indication that the RBI is keen on both inflationary management and nurturing the growth of the economy, particularly in the inclusive sense. May we hope that Governor Reddy will continue this policy stance of encouraging growth and stability in his future policy actions also.

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Stories in this Section
No tinkering

RBI restrains to surprise

Hands-off, deliberately

Opening door wider for MFs

Growth wins over inflation

Lull before the storm

Living with `impossible trinity'

An attempt at fine-tuning

No bark, no bite, only CAC

Emphasis on managing currency overvaluation

Leaving room for future action

A benign policy

Inflation control