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Madan Menon

The annual Monetary Policy announcement has come in the backdrop of the global financial and credit market turmoil. The economy has been adversely impacted by the global headwinds since last October, prompting swift and effective regulatory measures by the RBI and the government. The main objectives of the RBI have been to support growth by maintaining a soft interest rate regime along with provision of adequate bank credit and market liquidity.

The decision to cut policy rates by another 0.25 percentage points, following the rate reduction in the run-up to the announcement, is a concrete step from the RBI towards maintaining a low interest rate regime, especially taking into account a large government borrowings programme for the current fiscal year. The downward adjustment in banks’ cost of funds and lending rates induced by this cut will help revive private investment activity and spur growth.

Going forward, we could see the RBI move gradually on the policy rates front, given that liquidity in the banking system is comfortable, overall monetary conditions in the economy are significantly easy and bank lending rates have trended lower. The central bank will also maintain some policy headroom to accommodate any additional need for fiscal stimulus.

While the RBI has indicated that GDP growth would moderate further this year to 6 per cent from 6.5-6.7 per cent, we may fall short on account of the recessionary global economic environment. A more likely real GDP growth for this year could be in the vicinity of 5 per cent, given that the main driver of growth in recent years — private investment activity — is witnessing sharp moderation.

The RBI has rightly pointed out that India does not face a threat of deflation, even though the headline WPI-based inflation could be negative for some months. Its 4 per cent WPI inflation target for end-March 2010 takes into account that, while inflationary pressures remain subdued at the moment, inflation could be back in the positive territory in the second half of the year. The RBI’s bank credit growth estimate of 20 per cent looks aggressive considering 17.2 per cent growth last year. Any significant pick-up in bank credit is still three-six months away. Some of the institutional and market development measures announced in the policy are also welcome. Noteable among them is the introduction of STRIPS and interest rate futures. These instruments would help in creating a more vibrant and liquid debt market and in the development of a term money market.

More Stories on : Credit Policy | CRR & Bank Rates | Interest Rates

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