The Hindu Business Line : An attempt at fine-tuning

The Reserve Bank of India (RBI) has left all major policy instruments unchanged in the Credit Policy. There can be three reasons for this. First, the central bank is broadly satisfied that the inflationary crest is past and inflation will begin to decline and get set for the 2007-08 target of 5 per cent. Trends in price statistics and the anecdotal evidence of weakening domestic demand in some sectors, would justify this policy stance.

Policy balance

The second reason could be that the RBI is keeping the powder dry and watching for further signals and the playing out of the full impact of the higher cash reserve ratio (CRR) on liquidity from next week. Rather than act now and overcompensate, the RBI is attempting a more fine-tuning of the policy. This is indeed welcome.

The third and avoidable reason would be the RBI's oft-demonstrated penchant for taking the markets by surprise, done perhaps to achieve maximum policy impact but, at the same time, leaving the markets unsettled and not permitting the build up of any long-term expectations.

This will imply a sharper than usual hike in CRR and repo rates in the next couple of weeks, especially if food and commodity prices do not show signs of softening. It is always a difficult act to find the right policy balance, made more difficult by the burgeoning foreign capital inflows.

Therefore, the brunt of the RBI's intervention has been to try and restore the external sector balance by further weakening the incentives for foreign capital inflows and easing the conditions for capital outflows.

So the interest rates on FCNR (B) and NR (E) RA deposits have been further reduced and I do not recollect when these were 75 basis points below Libor! And firms, mutual funds and individuals are now given greater bandwidths for outward investments and remittances.

Sustaininng growth rates

However, these measures may not suffice to achieve an external capital-account balance. Primarily because the upward bias of the policy stance and the rising rupee represents a double winning bet for foreign investors who stand to gain both on account of a rising rupee and higher interest rates.

Some more sand in the system such as holding foreign capital flows in zero interest deposits may have helped. But, over all, it is not greater or lower capital inflows that will sustain high GDP growth rates.

The RBI can, perhaps, suggest or reiterate the agenda for structural reforms that will increase the economy's absorptive capacity for greater investment and raise the potential growth rate. This is perhaps a more important role today for an autonomous entity unencumbered by the pressures of coalitional regimes.

(The author is Director and Chief Executive, ICRIER.)

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No tinkering

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