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Toughest policy since Lehman collapse

Toughest policy since Lehman collapse

Mumbai: The third quarter monetary policy by the Reserve Bank of India (RBI) could prove to be the toughest for governor D. Subbarao since Lehman Brothers Holdings Inc.’s collapse in September 2008.

While the direction is clear, an expected resumption of monetary tightening, the way forward is more nuanced.

Inflation is high but is showing signs of moderating in the coming months. However, industrial production has fallen recently, unsettling the equation for RBI. Add to it the liquidity tightness in the banking system, which continues to stifle the system as banks have again started borrowing in excess of 1 trillion from RBI.

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The last time the central bank met to review its monetary policy in December, a rate hike was largely not expected. Instead, it was liquidity that attracted RBI’s attention.

In its mid-quarter review, the central bank tried easing pressure on liquidity at a time when banks were borrowing an average 1.04 trillion a day from RBI to meet cash requirements. It slashed the bond holding requirement of banks and offered to buy back 48,000 crore of government paper from the secondary market. But most importantly, the December policy marked the first pause in key rate increases in calendar 2010.

Tuesday could see a resumption of its monetary tightening exercise. Rising food and fuel prices have left RBI with no choice but to continue hiking its key policy rates. Comments by Subbarao earlier this month make this clear.

“When I meet other central bankers, they tell me why don’t you give us a bit of your inflation so that our growth will be faster. That’s how desperately they want some inflation and how desperate we are to control our own inflation," he said on 17 January.

RBI hiked its key policy rates six times in 2010, the latest in November as part of its “normalization process". It also said that further rate hikes are not likely in the immediate future.

In the interim, inflation accelerated to an annual 8.4% in December, and the October numbers were revised upward to 9.1% from 8.6%.

Fuel inflation rose 11.2% in December from 10.3% in November, pushing wholesale price inflation higher. Fuel products make up around 15% of the gauge, and with oil surging towards $100 (Rs ,570) a barrel, inflation is unlikely to go away in a hurry.

Analysts now expect RBI to raise its repo rate, at which it lends to banks, and reverse repo, the rate at which banks park their excess funds with it, by a minimum of 25 basis points (bps) each to 6.5% and 5.5%, respectively. A basis point is one-hundredth of a percentage point.

But while normalizing high inflation is the immediate concern, Subbarao’s challenge will be to find a delicate balance between rising inflation while ensuring growth is sustained.

Erratic industrial production numbers have added to the central bank’s misery. The Index of Industrial Production fell sharply to 2.7% in November, compared with a 11.29 % rise in October, official data showed, pointing to a weakness in growth.

RBI may also be careful not to ruffle market sentiment already hit by doubts over global economic recovery and rising local borrowing costs.

Sluggish bank deposit growth is another of Subbarao’s concerns. Deposit growth rose by an annual 16.5% against a target of 18%. Credit growth, on the other hand, has been faster at 24.4% year-on-year as of 31 December, more than RBI’s target of 20%.

Graphics by Yogesh Kumar/Mint


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