Unlike in April, Monday’s policy review wasn’t going to be easy. And it wasn’t. The central bank struggled to balance concerns over growth and with that over inflation. Growth won.
But in assuring that the easy liquidity conditions would be continued, the Reserve Bank of India (RBI) also gave fair warning that a return to more normal liquidity conditions was to be expected and that it would not take inflationary pressures lightly. For equal measure, the statement underscored that liquidity withdrawal would take place only after there were definite and robust signs of recovery. Policy rates were untouched. The market expected this and did not blink. All the action was in the words.
The economy has been in the mixed news zone for some time now. Industrial production has turned modestly positive and is expected to gather steam. Car sales have risen strongly and freight traffic is up. But non-oil imports have continued to contract as has credit growth.
With the economy yet to decisively step out of the shadows of the slowdown, easy monetary conditions are still needed. And RBI underscored that it would continue with this support until definite signs of recovery are visible.
On the price front, supply-driven food inflation has been firming up. The recent retail fuel price hike was a one-off event, but there is the deficient monsoon. Although there is still considerable uncertainty about how intense and widespread the deficiency might be, fears of rising headline inflation are palpable. However, there is little monetary policy can do to ease supplyside pressures.
So why warn the market? RBI’s concern is that the massive excess liquidity in the banking system sitting idly in reverse repo has the potential of suddenly turning into credit and fuelling goods, commodities, and asset price inflation. The warning is well taken, and RBI in the same breath underscored that any such withdrawal would take place only after demand and credit conditions turned around firmly.
We in the market love to read between the lines when it comes to RBI-speak, because we expect it to speak in tongues. Perhaps this is new RBI, which wants us to read its statements literally.
But if supply-side inflation sparks a rise in inflationary expectations, RBI will act to contain them quickly. This it has space to do. All of the excess liquidity at present amounts to roughly 200-250 basis points of the cash reserve ratio. Given its history, RBI won’t lose much sleep in hiking the reserve ratio by this much if needed, but not now. For now, RBI remains on the side of growth. The next few months will tell whether growth is on RBI’s side.
Jahangir Aziz is India chief economist, JPMorgan Chase. The views expressed are his own.
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