The half a percentage point cut in policy rate by the US Federal Reserve to 4.75%, reversing its more than three-year-old tight money policy, will put pressure on the Indian central bank against any immediate tightening of its policy either through a rate hike or a raise in banks’ cash reserve when it meets for the half-yearly review of its monetary policy next month. However, it will not change the bank’s track in favour of an accommodative monetary policy. Reserve Bank of India (RBI) governor Yaga Venugopal Reddy is expected to wait and watch and maintain the status quo for the time being.

The bond market is also not punting on any change in RBI’s policy stance. The 10-year bond yield came down by a few basis points on Wednesday to around 7.82%, reacting to the US Fed rate cut.

This is despite the fact that most bond dealers were expecting a quarter percentage point cut in the Federal Reserve policy rate.

RBI governer Y.V. Reddy

Subsequently, the norms for external commercial borrowing were tightened to rein in the flow of overseas money into the Indian financial system.

Since August 2003, when RBI started tightening its policy, the CRR has been raised from 4.5% to 7% and the policy rate from 4.5% to 7.75%. The US Federal Reserve started hiking the policy rate in June 2004, when the rate was ruling at 1%. It had raised it to 5.25% through 17 hikes.

The reversal of policy by the US Fed and a 17-month low inflation rate of 3.52% here, however, are unlikely to force RBI to change its stance.

At best, the bank may enter into a neutral zone with a bias towards tightness, depending on the movement of the inflation rate and flow of credit in the rest of the year.

Economists expect the inflation rate to come down further. In fact, the rate may veer to around 3.25-3.30% for the week ended 9 September, down from 3.52% in the previous week.

But there is very little to celebrate because the low level of inflation will be short-lived and it will start inching up when the base effect wears off. It has been going down because of a higher base a year ago.

The year-to-date inflation rate is more than 4.5% at this point of time.

The most critical pressure point is the surge in oil prices. US crude surged $1.81 (Rs72.9) to a record $82.38 a barrel on Tuesday and London Brent crude was up $0.60 to $78.19. “The underlying pressure on the inflation rate is very strong despite the present low level (of inflation). The global commodity prices are on an upsurge and this is bound to have an impact on the inflation rate. I don’t think RBI can afford to let its guard down," says an economist with a large corporation, who does not wish to be named.

The year-on-year credit offtake has come down to 23.2% after a steady 30% growth for three years in a row but the growth in money supply continues to be 20%, higher than the RBI-projected 17.5%.

Bankers expect the credit growth to gather momentum from October when the traditional “busy season" of the Indian economy kicks off after the harvest. The Indian economy grew at 9.3% in the April-June quarter of the current fiscal and with the monsoon being a normal one, economists are fairly certain of an 8.5-9% growth for the year.

Against this background, it is highly unlikely that RBI will cut the CRR or interest rate in its half-yearly review of the monetary policy to be in sync with the US Fed’s stance.

In fact, some of the analysts strongly feel that there is a case for further tightening of monetary policy later this year. Sanjit Singh, vice-president of ICICI Securities Ltd, which buys and sells government bonds, is one of them. “Unless there is a hard landing in the US economy followed by a collapse in the housing market, I think RBI will have to tighten its policy by the end of the year," says Singh.

That may happen next year. For the time being, RBI has other means to drain excess liquidity from the system to maintain its tight money policy without tinkering with the policy rates or CRR.

It can always issue bonds under the market stabilization scheme (MSS), created in 2004 to absorb excess liquidity.

The limit for MSS has recently been raised from Rs1.1 trillion to Rs1.5 trillion and Rs1.15 trillion of this has been used.

So, governor Reddy can tread on a neutral zone for the time being till he decides on his next course of action.