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Business News/ Money / Personal-finance/  Inflationary pressures persist, but liquidity is the need of the hour
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Inflationary pressures persist, but liquidity is the need of the hour

Inflationary pressures persist, but liquidity is the need of the hour

Graphic: Yogesh Kumar / Mint Premium

Graphic: Yogesh Kumar / Mint

On Thursday, Reserve Bank of India (RBI) governor D. Subbarao came, he saw and he paused, keeping the promises he had made at the 2 November meeting. What he saw wasn’t a cheery sight. He noted that international prices of commodities had risen noticeably and that inflation had started creeping up in most emerging markets. He said that inflationary pressures from domestic demand persist and that “The risk to the Reserve Bank’s projection of 5.5% inflation by March 2011 is on the upside".

Moreover, data released on Thursday also showed food inflation rising again, while the RBI statement said: “The pace of decline in food price inflation has been slower than expected due largely to structural factors." The hike in petrol prices and a probable increase in diesel prices will also add to inflationary pressures. The latest RBI numbers show that, as on 3 December, bank credit growth was 23% year-on-year. The RBI statement says that domestic growth momentum remains strong.

So why did RBI pause? Simply because liquidity has been too tight for comfort lately and Subbarao is worried it could affect growth. Of course, the way he put it wasn’t so simple—what the statement actually said was “the extent of deficit could constrain banks’ ability to expand their balance sheets commensurate with the productive needs of the economy. The additional liquidity measures initiated by the Reserve Bank respond to these concerns".

Graphic: Yogesh Kumar / Mint

The bond markets reacted favourably since the size of the open market operations announced was much more than expected. The Overnight Indexed Swap (OIS) curve steepened as the liquidity enhancing measures led to a fall in short-term rates. The stock market, too, saw a sharp pullback soon after the announcement of the policy, with the BSE Bankex rising 1.86%, a bit more than the Sensex. The Realty index, too, rose 0.98%. It’s doubtful whether the rise had much to do with the credit policy, though, because the IT index led the pack and IT stocks have absolutely no connection with the credit policy.

RBI’s decision to pause is unlikely to last long, given that the fall in inflation is largely a statistical effect and upward pressures persist, as detailed in the RBI statement. In fact, some economists expect the OIS curve to flatten again in anticipation of another rate hike in January, a hike hinted at by the RBI’s hawkish rhetoric. RBI will now have to look beyond normalization of its policy rate and start tightening in earnest.

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Published: 16 Dec 2010, 10:14 PM IST
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