The Hindu Business Line : RBI’S CREDIT POLICY FOR 2008-09<br>Growth, stability on even keel

The Credit Policy has not rocked the boat. It has preserved the broad emphasis of the central bank on growth with stability and is friendly to the economy, markets and infrastructure. It is to be hoped that the RBI
Governor’s objective of containing inflation will
be realised, says S.VENKITARAMANAN.

The RBI Governor, Dr Y. V. Reddy, has been true to his word and unveiled a package of relatively benign measures to fight the inflationary threat. Together with the Government’s fiscal actions, the RBI’s monetary policy aims at containing the inflationary expectations.

Governor Reddy has not raised the bank rate nor the repo rate, but has resorted to tightening liquidity, through an increase in the CRR to 8.25 per cent, with effect from the fortnight beginning May 24, 2008. Analysts calculate that this will mean an increased abstraction of Rs 9,000 crore, in addition to Rs 18,000 crore withdrawn by the RBI a few weeks back.

There is an expectation that this contraction in liquidity with the banks will reflect itself over time in a hit on the profit and loss statements of the banks and thus lead to a rise in interest rates charged by them. But this takes time to come into effect and the RBI is apparently hoping that the abstraction of Rs 9,000 crore in extra liquidity from the banks will help to control inflationary expectations.

It is, however, doubtful whether these aims will be realised in time. More importantly, the Central Government is taking actions on the fiscal side, such as reduction in duties and increasing availability of supplies. These will have a more immediate effect on inflationary expectations than the monetary policy changes announced by the Governor.

The Governor’s policy actions have, however, an important role to play in deciding the behaviour of market participants. They will take into account the continuing stance of the RBI in favour of sacrificing a little bit of growth to meet the goal of inflationary management.

Opinions are divided as to whether inflation in India, which is essentially determined by supply-side factors, such as the rise in crude oil price and food prices on a global scale, can be influenced by monetary measures. But I think the Governor has chosen an anti-inflationary stance as a better policy.

In spite of the contraction in liquidity, the Governor expects credit growth to be reasonable, although not at the same level as last year. Correspondingly, the rate of growth of GDP is also expected to be moderated to 8-8.5 per cent.

The most important message from the Governor’s policy statement is his determination to come up with measures, if necessary, as may be called for by the international and domestic developments and not to be deterred by the timing of the Credit Policy statement. This is line with central bank practices around the globe.

On exchange rate policy, the Governor has nothing new to add. He reiterates his earlier stance that has guided the exchange rate policy in recent years. This is governed by broad principles of careful monitoring and management of exchange rates with flexibility without a target of a pre-announced rate on a bank, coupled with the ability to intervene if and when necessary.

Intervening when necessary is a “catch-all” term. Whether the competitiveness of Indian exporters is taken into consideration is a matter that can be debated. The overall approach, which the Governor has described, may need some change.

Inflation strategy

The expectation of the Governor that the inflation rate will be brought down to around 5 per cent in the medium term and 3-4 per cent in the longer term seems to be optimistic, considering the pressures of global prices on the domestic economy. However, these are desirable goals.

The question remains, however, that the trade-off with growth engendered by such single-minded concentration on inflation will not affect the poverty alleviation goal of the Government. I am sure the Governor will find appropriate responses to these challenges.

All in all, the latest Credit Policy has not rocked the boat. It has preserved the broad emphasis of the central bank on growth with stability. While there are suggestions that credit growth should be restricted, there are also measures, such as those on housing, announced by the Governor, which will induce a desirable expansion in credit.

The Credit Policy is, on the whole, friendly to the economy, markets and infrastructure. It is to be hoped that the Governor’s objective of containing inflation will be realised, aided and abetted by the improved prospects on the food production front and actions taken by North Block.