Mumbai: For Reserve Bank of India (RBI) governor D. Subbarao, the January review is the most challenging ever since he took over as the country’s chief money man in September 2008, barely a fortnight before the global financial sector meltdown swept India following the collapse of Lehman Brothers Holdings Inc. Subbarao cut the policy rate aggressively from 9% to 3.25% and banks’ cash reserve ratio (CRR) from 9% to 5% between October 2008 and April 2009, to prop up a slowing economy.

But this time around, his focus is on “managing recovery" and not “managing crisis". Describing himself as a warrior entering the chakravyuh of the epic Mahabharat, where it was easy for warriors to enter the formation of the enemy but almost impossible to get out, Subbarao said the future of the policy stance is clear—that of tightening. Edited excerpts from his media briefing:

On exiting the expansionary monetary policy

I must admit that this time around the policy decision was much more complex and much more challenging than in the last one-and-a-half years. Getting out of an expansionary policy is incredibly more complex than getting into it…it’s like chakravyuh of Mahabharat; it’s very easy to get in but very difficult to get out. Not many people know how to get out as we know all the central banks in the world are struggling with that.

During the crisis, the tolerance for error was larger because people were saying that it’s better to err on too much than too little. Now the tolerance for error is low. So we have to calibrate our policy very carefully.

On the direction of future policies

Urgent requirement: D. Subbarao said RBI decided to absorb liquidity by a predictable amount now and go for other measures later. Santosh Hirlekar / PTI

On CRR hike and keeping key rates unchanged

We determined that the process of normalization has to begin by absorbing liquidity. A CRR hike of 75 basis points will withdraw liquidity by a predictable amount. If we had used an interest rate measure, the amount of liquidity that we would have absorbed on a day-to-day basis would have been unpredictable, and given the large amount of liquidity (now), we wanted to be certain about how much of liquidity we are going to absorb.

We have done detailed calculations on the liquidity in the system over the next several weeks and it is our understanding that there will be sufficient liquidity in the system even after this CRR hike comes into the effect finally on 27 February to meet the potential demand for credit from the private sector.

On whether policy rate hikes were considered

Yes, raising the reverse repo rate, or both repo and reverse repo, was in the consideration. But in the end, we decided to absorb liquidity by a predictable amount and go for other policy measures later. We did take into account all possibilities, positive and negatives of measures and determined that this is the most appropriate at the current level.

On growth and recovery

The recovery is not broad-based and we need to encourage more investments in supply before the output gap gets closed. So, it’s important that we support the recovery process in order to control inflationary pressures from the demand side. Also, on growth-inflation trade-off, it’s important to recognize that even as there is some trade-off in the short term, if you look slightly beyond the short term, inflation will anyway continue. So we had to take into account inflation concerns and growth considerations. We expect that the CRR hike will anchor inflation expectations without hurting growth impulses.

On growth prospects after withdrawal of stimulus

I cannot give such an absolute and established assurance. But we have made some assumptions about the fiscal stance of the government and we have also made a comment on the fiscal stance of the government. On our growth projection, there are upside possibilities and downside risks.

In the last policy review we had pointed out that growth was largely driven by fiscal stimulus. Since then we have more recent numbers. Private consumption and private demand have started picking up. So we are not that critically dependent on fiscal stimulus as we were six months ago. We believe that this Budget must begin the process of fiscal consolidation.

On the government borrowing programme

As per our assumptions, the borrowing programme of the government (next year) will roughly be similar to this year. In absolute terms, it will be higher because there is quite a bit of redemption coming in 2009-10.

On challenges in managing the borrowing programme

By all accounts, as all of us know, the government borrowing next year will be more challenging than it was this year for a number of reasons. I think the government borrowing programme could be more challenging, but we are hoping that with the cooperation of all market participants, we can manage that.

On capital flows

We don’t intervene in the market unless there is volatility. It is expected that capital flows will increase in an emerging markets economy and they will increase even in india. It is not clear what policy measures we might take to manage capital flows.

As in the past, we will manage the capital accounts in a manner that is appropriate to the size and expected volatility of the flows. We have sufficient experience both in the government and in the Reserve Bank, and based on the experience, we will seek appropriate actions in the months ahead, should capital flows be totally out of line with our macroeconomic calculations.