The Hindu Business Line : RBI, Fed keep stance

It’s all over bar the shouting. The RBI finished with its annual policy announcement as did the US Fed with its interest rate-setting Federal Open Market Committee (FOMC) meeting.

True to its form in the last year-and-a-half, India’s central bank preferred increasing the CRR to the repo rate. Banking system liquidity drives market interest rates, not the policy rates. The forward increase in the CRR (the latest rise is effective late May) reflects the RBI view that the liquidity overhang will continue for some time to come, thanks to robust government spending and (perhaps) the RBI’s own dollar support intervention. In fact, the quarterly policy announcements are likely to diminish in importance as market events force the central bank into frequent pre-emptive measures ahead of policy.

While banks are being persuaded not to raise their lending rates, any CRR increase translates into an increase in their cost of funds. Moral suasion (and competition) could, however, compel them to stay their hand on interest rates.

That said, the fact remains that the cost of money, especially for blue chip corporates, remains well below their profit rates. It is small business and consumer credit which bear the brunt of the hardening of interest rates – another instance of the weak subsidising the strong?

Challenging times are ahead. As the Governor, Mr Reddy, says, global financial risks and rising commodity prices dominate the landscape. The RBI’s monetary management in these turbulent times has been extraordinarily skilful. Given its safe pair of hands, India should navigate possible global and domestic economic and financial headwinds with limited impact.

The stream of US data continues largely negative. But Q1 GDP growth was 0.6 per cent. Technically, the US is not in recession, but the descent from levels of 3 per cent is so sharp that it makes little difference. Consumer confidence and business sentiment continue to plunge. The housing crisis is worsening. Worried though it is about inflation, the Fed stuck to its softening policy, cutting rates by 25 bps (with two dissenting members favouring no change).

Ironically, stock markets are rallying even as the economic news gets gloomier. If that is seen as a leading indicator, a resumption of growth may be around the corner. Bonds also tell the same story, with two-year Treasury yields jumping almost 150 bps in just the last two to three weeks. Credit spreads are shrinking, but inter-bank rates are still far from normal. Still (for the present?), the worst has passed.

Is it for real or a false dawn? The prognosis must be that if commodity prices keep falling, as they have in the last few days, things can only look up.