The Hindu Business Line : RBI likely to be on hold

After cascading to double digits in leaps and bounds, inflation has taken a respite, stabilising in the 11-12 per cent range in the last few weeks. The Reserve Bank of India must be thankful for small mercies. Its Quarterly Monetary Policy Review, due today, thus need not be a fire-fighting exercise.

The central bank did well to effect quick increases in the cash reserve ratio (CRR) and repo rates in the last few months as inflation climbed and there was surfeit liquidity in the banking system.

Money rates have settled at the upper end of the 6-8.5 per cent corridor of reverse repo and repo rates, just as perhaps the RBI would like.

Banks have turned borrowers in the daily liquidity adjustment facility after the successive CRR hikes.

That may be short-lived. Government expenditure will keep the money market well supplied, unless there is forced intervention to support the rupee, which, at the moment, looks unlikely (and unnecessary).

It wouldn’t be surprising if money rates trade down in the next weeks, necessitating another CRR increase. As stated in this column on several occasions earlier, in the Indian context, system liquidity matters more than policy rates. Thus the RBI (like its Chinese counterpart, the People’s Republic Bank of China – PRBC) will rely on reserve ratio changes to drive money rates toward policy rates.

The more important aspect is that repo and CRR changes are no longer necessarily tied to the policy reviews.

They could and have in the last couple of years been done between reviews, as incoming data necessitates immediate action. Like time and tide, inflation waits for no man (or, it must be added, perhaps, no central bank).

What’s in store

What’s, therefore, in store in the current review?

Apart from inflation ceasing to rise, crude prices have fallen sharply to $120 levels from close to $150 in a fortnight. Commodity prices too are trending down. While it is hazardous to make any forecast in these volatile times, it does appear oil and commodity prices have peaked as demand has ebbed in response to soaring prices and declining business conditions. The pressure from imported inflation is softening. Asset prices – another major source of worry – are also reversing direction, with significant falls being seen in stocks and property.

Summer – usually a period of rising prices – is over. The monsoon and agricultural season herald lower inflation in the weeks ahead.

The RBI might well decide not to disturb rates and the CRR in this review with the caveat that money rates will not be allowed to stray too far from the repo rate.

Expect more CRR than rate tinkering in the coming months.

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