The Hindu Business Line : Maintaining stability

The RBI continues to re-emphasise its policy preference for maintaining price stability and well-anchored inflationary expectations. However, given the sudden spurt in capital inflows beyond absorptive capacity, the near-term policy focus remains centred on foreign exchange stabilisation. The hike in the cash reserve ratio (CRR) by 50 basis points, a move intended to contain the surplus liquidity in the system, was in line with market expectations.

The RBI should be commended for not altering the policy rates at this juncture. Upward price pressures remain quite significant in India, with the supply side constrained by four-five consecutive years of above-trend growth. Inflation could also accelerate towards the year-end, on less favourable base effect and intensifying demand pressure following the recent easing of lending rates. Incomplete pass-through of international prices of crude, metals and food commodities, in general, to consumer prices is indicative of suppressed inflation, which carries a destabilising potential into the future.

Demand pressures

GDP growth forecasts have been retained at 8.5 per cent, assuming no further escalation in international crude prices and barring domestic or external shocks of significant magnitude.

It appears that the excess demand pressures have moderated, which leads us to believe that the RBI has reached the peak of its interest rate cycle. Interest rate hikes done in the past targeted at dampening domestic demand achieved their intended purpose. It is quite possible that holding interest rates at these levels for some more time against the backdrop of rate-cuts by developed countries could potentially attract more capital inflows, reducing the efficacy of monetary policy tightening by expanding domestic liquidity.

Development of the corporate bond market is an urgent necessity, and the RBI has expressed its commitment for permitting market repos in corporate bonds.

Thus, balancing growth and inflation is going to be a key challenge for the RBI going forward.

(The author is Vice-President, Finance, L&T).

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