The macro economic outlook released ahead of the Monetary Policy provided clarity on the issues and execution strategies to mitigate risks to the economy. Global cues are bearish through high commodity prices exerting inflationary pressures and low demand not being supportive to the growth momentum. Domestic cues are mixed, supply-side issues exerting pressure on inflation and good domestic demand supporting growth momentum.

Given the macro economic conditions of high growth and high inflation scenario, it is important for RBI to be supportive to address the inflation side with higher priority, but without hurting growth momentum. The desirable approach was to take a moderate stance with a good blend of anti-inflation and pro-growth measures.

The Reserve Bank of India's other concerns are inflation-adjusted real interest rates and transmission of Policy rates in the deposit and lending rates. This is achieved through maintenance of short-term liquidity in the system over the 1 per cent NDTL tolerance level. The current cash shortfall of 2.0-2.5 per cent of NDTL has achieved these two objectives with the 12-month deposit rate over 9.75 per cent against the headline WPI of 8.5 per cent and overnight rate trading at 50 basis points above the operative policy rate.

‘Wait and watch'

The RBI's guidance ahead of the Policy was clear that it would wait and watch till supply-side measures kick in the desired results on inflation and limited impact on food, fuel and primary articles inflation through tight monetary measures. Having said this, the need is to stay supportive to arrest any kind of demand side pressures creeping in to make things turn from bad to worse. This is what RBI has precisely delivered in this monetary policy to maintain price stability at current levels. The need was not to send any signals to trigger runaway moves either-way. So, the delivery of 0.25% hike in policy rates and extension of LAF support crossing FY11 was to the expectation of market stake holders, while it was pleasant surprise for few who were expecting a more hawkish stance.

Way forward

The way forward, however, is not yet clear. Despite upward revision in inflation target to 7 per cent, there is limited confidence to achieve this target from the current level of 8.5%. The data from now on will be crucial to set up the next course of action. Having said this, commodity prices are showing signs of reversal and a good Rabi crop would ease food price inflation; thus no need to get bearish at this stage.

It is prudent to stay cautious with mild bearish bias into the future till confirmation of reversal in inflation pressures. Till then, short-term interest rates are to stay at elevated levels, considered good for investors, and higher interest cost to borrowers.

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