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Governor keeps his promise

Governor keeps his promise
The Reserve Bank of India sees need for continued monetary vigilance on consumer price inflation, though moderating, and thus leaves policy rates unchanged (repo at 8 per cent as before). At the same time, it is providing further liquidity support for credit expansion to productive sectors, given improving growth prospects.

Accordingly, Statutory Liquidity Ratio (SLR) is cut from 22.5 per cent to 22.0 per cent of net demand and time liabilities of the banking system, with effect from the fortnight beginning 9 August. In the Third Bi-Monthly Monetary Policy Statement of 5 August, RBI Governor Raghuram Rajan takes note of Budget commitment to fiscal consolidation and deficit target of 4.1 per cent of GDP in
2014-2015, and says this opens up space further for banks to expand credit in response to financing needs as growth picks up.

Rajan would appear to have finely balanced the twin objectives of growth and price stability - in the context of uncertainties yet to be overcome for a sustained disinflationary course to facilitate easing of monetary policy on the one hand, and of improved outlook for growth reinvigoration, on the other.

RBI had cut SLR by 50 basis points earlier in the Second Bi-Monthly Policy Statement of 3 June, from 23 per cent to 22.5 per cent ‘in anticipation of economic recovery’. In the Third bi-monthly statement now, a further cut to 22.0 per cent of NDTL of banks has been made. In consonance with the calibrated reduction in the SLR, it is necessary to enhance liquidity in the money and debt markets so that financial intermediation expands apace with a growing economy, it said.

The policy repo rate under the liquidity adjustment facility (LAF) is unchanged at 8.0 per cent and so also the cash reserve ratio (CRR) of scheduled banks at 4.0 per cent of NDTL. Consequently, the reverse repo rate under the LAF will remain unchanged at 7.0 per cent, and the marginal standing facility (MSF) rate and the Bank Rate at 9.0 per cent. Rajan’s assessment is globally, investor risk appetite has buoyed financial markets, partly drawing strength from assurances of continuing monetary policy support in industrial countries.

While portfolio flows to emerging market economies (EMEs) have risen strongly, Rajan points out, it implied that they remain vulnerable to changes in investor risk appetite driven by any reassessment of the future path of US monetary policy or possible escalation of geopolitical tensions.

On domestic situation, RBI sees economic activity reviving, with incoming data suggesting a firming up of industrial growth and exports and improvement in business expectations along with early signs of modest strengthening of corporate sales and business flows. Earlier concerns on progress of monsoon have also been mitigated, though not entirely dispelled.

The Governor believes that implementation of government policy actions that have been announced (so far) should create ‘a congenial setting for a steady improvement in domestic demand and supply conditions’. However, Rajan has caveats on both sustained moderation in CPI and the economy’s growth target (RBI had projected 5.5 per cent for current fiscal while the budget assumption is 5.4 to 5.9 per cent).

While retail inflation measured by the consumer price index (CPI) has eased for the second consecutive month in June, and higher prices of vegetables, fruits and protein-based food items were offset by the muted increase in the prices of non-food items, there is continuing uncertainty about the monsoon. It would be therefore, premature to conclude that future food inflation, and its spill-over to broader inflation, can be discounted, he says.

He also cites upside risks in the form of the pass-through of administered price increases, possibly higher oil prices stemming from geo-political concerns and exchange rate movement, and strengthening growth in the face of continuing supply constraints. Since there remains the upside risks to the target of ensuring CPI inflation at or below 8 per cent by January 2015, Rajan considers it appropriate to continue ‘maintaining a vigilant monetary policy stance as in June, while leaving the policy rate unchanged’.

Taking a cautious stand on the growth target as well, Rajan lists some pre-conditions for sustaining the central estimate of real GDP growth at 5.5 per cent. The recent pick-up in industrial activity has to be sustained in an environment conducive to the revival of investment and unlocking of stalled projects.

Secondly, ongoing fiscal consolidation should release resources for private enterprise, thirdly, external demand should be picking up and lastly, international crude prices should be stabilising. ‘On the other hand, if risks relating to the global recovery, the monsoon and geo-political tensions intensify, the balance of risks could tilt to the downside’, Rajan added.

The coming months will be crucial for ensuring that all the needed steps are in place for securing the targeted growth as well as CPI inflation remains on a steady moderating course. For its part, Rajan says, RBI will continue to monitor inflation developments closely with its commitment to the disinflationary path of taking CPI inflation to eight per cent by January 2015 and six per cent by January 2016.

The central bank’s policy objectives in the growth-inflation dynamics hinge on government actions in the months ahead on food management and facilitating project completion which should improve supply.

As consumer and business confidence pick up, aggregate demand will also strengthen, and Rajan says RBI would act as necessary to ensure sustained disinflation. IPA

S Sethuraman

S Sethuraman

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