India has witnessed one of the longest spells of food inflation, which often rose to double digits, and spilled into general inflation. The Reserve Bank of India has fought valiantly with repeated rate hikes and monetary tightening. At last, the battle appears to have been won, with food inflation declining for the fifth consecutive week, and general inflation coming down. However, the war remains to be fought. Only a massive, concerted supply-side response can make a dent in the war against inflation. It is in this background, that the mid-quarter monetary policy has been framed. The policy rate hike has been paused and kept unchanged at 8.5 per cent. Consequently, the reverse repo rate under the LAF will remain unchanged at 7.5 per cent, and the marginal standing facility (MSF) rate at 9.5 per cent.

The timing and magnitude of further actions will depend on a continuing assessment of how inflation and other factors shape up in the months ahead. Both inflation and inflation expectations are currently above the comfort level of the Reserve Bank.

However, with moderation in food inflation in November 2011, and expected moderation in aggregate demand and hence in non-food manufactured products inflation, the inflation projection for March 2012 has been retained at 7 per cent.

For the present, RBI perceives that downside risks to growth have clearly increased. Therefore, based on the projected inflation trajectory, further rate hikes might not be warranted. On the other hand, future monetary policy actions are likely to reverse the cycle, responding to the risks to growth. In any case, Reserve Bank will reveal its revised assessment of its growth and inflation projections for 2011-12 in the third quarter review of January 2012.

Liquidity deficit has increased significantly from the second week of November 2011, the average borrowings under the daily LAF increasing to around Rs 89,000 crore, against the comfort level of Rs 50,000 crore. Open Market Operations by the RBI have already pumped in Rs 24,000 crore to ease liquidity conditions. Further OMOs will be conducted as and when signs of stress are seen. With this assurance, the bond yields are expected come down with 10-year nearing 8.25 per cent.

As no additional liquidity is pumped into the system, as expected by the market, the deposit and loan rates are likely to remain at the current levels till January-2012 quarterly policy.

(The author is Chairman and Managing Director, Indian Overseas Bank.)

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