Reserve Bank of India Governor Raghuram Rajan had to set out the second bi-monthly monetary policy for 2014-15 on June 3, playing his cards blind. Normally, by this time of the year, the Budget is announced and the task of the RBI becomes clearer.

This year, because of the general election, the Budget has been scheduled for early July. As such, the RBI had a tough call to make. Given the circumstances, the RBI cannot be faulted for its somewhat emollient monetary policy stance.

Macroeconomic backdrop The RBI has done well to push through its preference to monitor inflation based on the Consumer Price Index (CPI) and firmly reiterated its objective of containing inflation within 8 per cent in January 2015 and 6 per cent in January 2016.

The outlook on the agricultural front is somewhat uncertain with the delayed monsoon and the possibility of the El Nino effect.

While keeping inflation down to 8 per cent by January 2015 appears attainable, containing inflation within 6 per cent for January 2016 could be a tough call given the uncertainties regarding the global economy and the extent of Indian fiscal adjustment.

There is considerable repressed inflation through low administered prices but if these prices are raised, it will reflect in inflation. If administered prices are not raised, it will show up in a higher fiscal deficit. Either way, it will be a problem that monetary policy will have to face. The balance of payments current account deficit (CAD) of 1.7 per cent of GDP in 2013-14 appears to be artificially low and is bound to widen in 2014-15.

Stance of monetary policy The real GDP growth is projected at 5.5 per cent in 2014-15.The issue is whether the monetary policy stance was excessively accommodative.

The statement says that if the economy stays on course “further policy tightening will not be warranted … if disinflation, adjusting for base effects, is faster than currently anticipated, it will provide headroom for an easing of the policy”.

Markets would be right to interpret this statement as backing off from the earlier hawkish stance. One fervently hopes that the uncertain overall situation does not force a sharp turnaround of the policy stance as this would bring into question the credibility of policy statements.

Policy measures The policy measures are broadly reasonable but some caveats would be in order.

(a) Unchanged RBI policy rates: The maintenance of the status quo on RBI policy interest rates is unexceptionable, but the broad forward guidance could be embarrassing.

(b) Reduction in sector-specific refinance: While while obtaining the Asian Development Bank financial sector loan in 1992, the Indian authorities had committed themselves to abolishing sector-specific refinance. Far from adhering to this commitment, sector-specific refinance has been enhanced.

As such, reducing export refinance from 50 per cent of eligible outstanding export credit to 32 per cent is a commendable structural measure. The RBI would be well advised to phase out export refinance expeditiously as the experience is that the export lobby claws back the reduced refinance. Accordingly, the RBI would be well advised to reduce, at the August 5 policy review, export refinance from 32 per cent of export credit outstanding to 16 per cent and totally phase out the facility in October 2014.

As the export refinance is phased out there could be a corresponding increase in the term-repo facility.

(c) Reduction in SLR: The reduction in the statutory liquidity ratio from 23 per cent of net demand and time liabilities (NDTL) to 22.5 per cent would imply an absolute reduction of ₹42,000 crore.

There are reports that the borrowing programme in the Regular Budget will be raised by ₹70,000 crore, over the figure in the Interim Budget for 2014-15. Although banks’ holdings of securities is as high as 27 per cent of NDTL, the reduction of SLR could jeopardise the government borrowing programme and push up yields on government paper. It would have been best if this measure had been been examined at the third bi-monthly policy review on August 5.

(d) Outward capital remittances by resident individuals: Under the Liberalised Remittance Scheme (LRS) for resident individuals, outward capital remittances were reduced from $200,000 to $75,000 per annum. The measure announced on June 3, 2014, to raise this limit to $125,000 would raise confidence that the problems of mid-2013 have passed.

Unfortunately, the operating instructions are coy as they imply that the prohibition on purchase of immovable property continues. There is a lack of transparency in the operating guidelines.

In the August 2013 operating guidelines it was clearly stated that the funds could not be used for purchase of property abroad. In the June 2014 operating guidelines there is a reference to prohibition on the use of outward capital remittances for “margin trading, lottery and the like”. The reference to “the like” would imply that the prohibition on purchase of property continues.

The writer is a Mumbai-based economist