What RBI has in mind for April 20: Financial Express, April 16 2010

The Annual Credit Policy to be announced on April 20 is significant for several reasons. To begin with, we would get a clearer picture of the state of the economy. For the moment, we have claims made by various ministries on the progress of their sectors such as agriculture, industry and trade as well as the forecasts of various analysts. RBI’s review will tell us whether the overall GDP growth figure is at 7.2% or closer to more optimistic numbers in the vicinity of 8.5%. The GDP growth number may not have been more than a number in normal circumstances, but at this point in time, the entire policy stance for the year hinges on the actual state of the economy, which, in turn, is encompassed in this number. This will be the starting point of the theme of monetary policy for the rest of the year. Now, conducting monetary policy has often been likened to manoeuvring one’s vehicle through inclement weather with a fogged windshield, keeping an eye on the rear view mirror and shuffling one’s foot between the accelerator and the brake. This analogy will prevail during the year that will make monetary policy more interesting. The 2009-10 picture is the rear view, which should be clear at the time of the policy announcement when we will find out whether we are back on a high growth path. The windshield will continue to be foggy given the imponderables such as monsoon, industrial growth, foreign inflows, global recovery and actions of other central banks, inflation, etc. The decision has to be taken based on these silhouettes. But, what is certain today is that inflation will be the big challenge during the year, even though numerically it would be lower than the current double-digit rates due to the high base year effect. A double-digit level of both WPI and CPI is serious business and while it has been argued that these numbers were brought about on the food side, the scenario is changing gradually. The high IIP growth numbers show a distinct sign of robustness that is supported by the better trade numbers. Hence, there is reason to believe that the economy may be heating up and that core inflation will begin to surface. This is a close call that RBI has to take since monetary policy has to be forward-looking and pre-empt inflation rather than act when inflation has occurred. So, any action on interest rates will be the revealed stance towards the quality of inflation. The GDP growth figure will only make RBI’s decision a bit easier to take, as the classic trade-off between growth and inflation does not exist if growth is robust. But what about the CRR? Currently, there is adequate liquidity, as evidenced by the flows into the reverse repo auctions, which are of the order of over Rs 50,000 crore. RBI has already buffered for the government’s borrowing programme of Rs 4.57 lakh crore by announcing higher level of auctions of GSecs during the first half of the year, which by itself is an effective way of absorbing surplus liquidity while simultaneously meeting the fiscal deficit requirement. Also, RBI has announced that it would start picking up MSS bonds worth Rs 50,000 crore. These bonds did come in handy in 2009-10 in helping RBI complete the borrowing programme of Rs 4.51 lakh crore along with steady OMOs. The two did help to cover 24% of the gross borrowing programme. Therefore, given that RBI has set high targets for the first half for the government’s borrowing programme as well as MSS, there is reason to believe that a CRR hike may be deferred for the time being and the focus will be more on interest rates. However, the reaction of banks to rate changes appears to be uncertain. In the past, it has been observed that they have been swifter to change deposit rates rather than lending rates. Over the last year, while the average PLR has come down by just 50 bps, deposit rates (1 year tenure) came down by 150 bps. Further, the implementation of the base rate concept would make banks rework their rates, which may not be in alignment with the policy rate changes. However, RBI’s core focus will still have to be on liquidity management, as it has to balance the government’s borrowing requirement with the demand from industry for bank funds. Last year there was lower growth in both deposits and credit, which is unlikely to be the case this year. Demand from industry will increase and hence monetary policy has to be interactive through the year to balance liquidity with demand. Hence, we should probably be prepared for more fine-tuning à la Keynes during the year.