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The run-up to Reserve Bank of India (RBI)'s Annual Policy statement for the year 2011-12 has been relatively quiet this time in terms of developments in the economy and markets.
Growth is back on track, banking indicators have shown improvement, there is no sign of unease in the external sector — but, of course, taming inflation has remained elusive. Policy decisions such as raising repo rate under liquidity adjustment facility (LAF) by 50 basis points to 7.25 per cent, are in alignment with market expectations. But the noteworthy improvements include modification in the operating procedure, as per the Mohanty Working Group's recommendations, and in some technical analysis.
Removing some of the earlier confusions, it is explicitly stated that weighted average call rate will be the operating target of monetary policy and Repo rate under LAF will be the single policy rate. Bank Rate remains a separate policy rate without any significance in the Statement, contrary to the Working Group recommendation to activate it by linking to the Repo rate. These moves mark a significant shift.
USE OF MACRO INDICATORS
Moving away from exclusive reliance on monetary aggregates for the conduct of monetary policy, the RBI has adopted the ‘multiple indicators approach' since 1998-99.
Under this approach, it has been using a host of macroeconomic variables in addition to monetary aggregates as policy indicators to draw a policy perspective. GDP growth and inflation, growth in broad money (M3), bank deposits and credit are used as indicative projections. As regards inflation, actual outcomes remained within the targets (usually inflation projections are set below a particular rate) on eight out of 10 ten occasions since 1999-2000.
However, as regards GDP growth, projections underestimated growth during upwards swings and overestimated the same during an economic slowdown. The present Statement improves the credibility of the growth projection by assigning 90 per cent probability within the range of 7.4 per cent to 8.5 per cent.
TECHNICAL ERRORS
While difficulties in economic forecasts are understandable, misalignment in actual projections for growth in M3 and bank credit reflects technical errors. For example, while GDP growth and inflation projections were hiked from 6 per cent and 4 per cent in 2009-10, respectively, to 8 per cent and 5.5 per cent, in 2010-11, indicative projections for M3 growth and bank credit were kept unchanged.
On this aspect too, the present Statement is a technical improvement, lowering M3 and credit projections consistent with a lower inflation objective. Moreover, the analysis is quite comprehensive and convincing.
(The author is Reader, Department of Economics, Pondicherry University.)
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