The Hindu Business Line : No tinkering

The Annual Policy Statement 2007-08 by the Reserve Bank of India is memorable not because it left interest rates untouched but because it has nudged the country closer to a fuller float of the rupee. In knee-jerk fashion, however, the market responded to what the RBI did not do, and the Sensex moved north. That bank stocks led the rally indicates the sheer relief of the market at not being punished, as it were, with another round of rate hikes. But, then, the RBI had no need to tinker with interest rates; successive benchmark rate hikes over the last 18 months are beginning to have effect. Already new customers are shying away from expensive retail and home loans and more will do so as the RBI's tacit message, echoed by the Finance Minister, to moderate credit growth embeds itself into banks' agendas. Assuming the battle against easy money as almost won, the RBI pegs the non-food credit growth at 24-25 per cent, a decline of nearly five percentage points from the average growth over the past four years.

Despite the rhetoric of growth that the Credit Policy is suffused with, despite the pegged down GDP rate of 8.5 per cent, the RBI's central concern is to haul inflation back under the 5 per cent level. It expects that a slower credit offtake by the non-food sector will work the desired result. But contrary to what Milton Friedman had to say about inflation being a purely monetary phenomenon, the current price rise (at the Consumer Price Index level it is close to 10 per cent for the most vulnerable) is not demand-generated but supply-constrained. This is fairly well known and the RBI adds its bit by introducing a credit guarantee scheme for distressed farmers. Yet, its focus remains price stability amid growing liquidity, abetted by growing foreign exchange reserves and the need for rupee resources for the domestic economy. Simply lowering GDP forecasts by half a percentage point will not turn off the tap. At this point the policy becomes memorable.

Two working groups will look into futures markets for interest rates and currency; hopefully, the process will not remain endless, mired in one muddy swamp or other. The Credit Policy has raised the limits of foreign exchange for individuals as also companies and mutual funds some more. This should ease the pressure on reserve build-up (and on inflation somewhat) and encourage the productive outflow of investments by companies capable of global acquisitions. Permitting a higher prepayment of External Commercial Borrowings without RBI permission should send the right signals to global investors about an economy on the move. Whether inflation is controlled remains to be seen.

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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