The Reserve Bank of India (RBI) governor clearly dislikes volatility, not just in financial markets but also in policy actions. So, it is hardly surprising he eschewed hiking either reverse repo or repo rate and stuck to a modest hike in credit reserve ratio (CRR). Though the policy states price stability as its main objective, the actions taken, and the professed path look equally protective of growth.
The central theme of the policy revolves around using only capital and liquidity management measures as the immediate and continuing response to elevated inflation readings. Towards that, it asserts that risks to global growth are more pronounced on the downside, there are improvements in the “supply elasticity” of the domestic economy and there is likely reduced pressure on food prices due to bumper rabi crop and good monsoon outlook.
Clearly, RBI is facing a complex policy environment.
The seeming political imperative of limited rupee appreciation has deprived it of a key tool to contain imported inflation. Also, there are hard choices to be made in the face of clouded growth outlook, on the one hand, and the conflicting pressures exerted by financial contagion and rising inflation, on the other hand. The possibility of US-led global slowdown versus domestic consumption getting a boost from expansionary fiscal policy adds to the conundrum.
On the whole, the policy takes a precautionary rather than an unduly worried stance.
Ultimately, the path chosen by RBI reflects enhanced confidence among policymakers over future direction of inflation at this point of time. There is no sense of worry on count of entrenched inflationary expectations. As a direct result, the central bank sounds optimistic on projected gross domestic product (GDP) growth for FY09 in the 80-8.5% range. It is possible that RBI may revise this target in mid-year review but, for now, it wants to sustain consumer and business confidence.
However, lagged effects of past tightening, slowdown in global demand for domestic exports and some loss of momentum in investment demand may cumulatively result in GDP growth being below RBI’s target.
While moderation in headline inflation to 5-5.5% by the end of FY09 is likely, it may continue to rule above 6.5% over the next six months. In this scenario, RBI faces the risk that inflation expectations could worsen.
As a result, diligent liquidity suction measures, as outlined in the policy, are more likely than not. It would not be a surprise if there is a further CRR hike in the current quarter itself.
For the bond market, the uncertainty over rate hikes has been removed for now.
However, relatively tight liquidity conditions and extra-budgetary supply of special securities would preclude any large dip in bond yields. The conduct of market stabilization scheme programme and inflation readings would remain key variables in dictating price volatility on a week-to-week basis.
Bank lending rates are unlikely to go up in the near future. The lending growth target of 20% can be met by extrapolating the current continuing slowdown itself without any need to force a correction.
The story on deposit rates, however, is more likely to be the outcome of competitive pressures than anything else.
Nitin Jain is managing director and CEO, ICICI Securities Primary Dealership Ltd.