As expected, Reserve Bank of India’s second quarter review of the monetary policy kept the key policy rates i.e. the repo rate (4.75%), reverse repo rate (3.25%) and cash reserve ratio (5 %) intact. The only policy action that was undertaken was the hiking of the statutory liquidity ratio (SLR) from 24% to 25%. The hike in SLR as such doesn’t make much sense in the present scenario. The commercial banks have already been investing heavily in government securities with investments in SLR investments hovering around 30.4% (of net demand and time liabilities (NDTL), October 2009) as compared to 25% last year. The hike in SLR can be considered only as a signal showing RBI’s concern for inflation and as a ‘soft’ tightening measure to combat the excess liquidity in the economy. However, the status quo has been maintained on the back of higher future inflationary expectations (WPI inflation) by the RBI by raising its inflationary projection at the end of the year to 6.5% from the earlier 5%.
But does the data justify the status quo maintained by RBI?
The inflationary scenario seems to be a cause for concern. Inflation (y-o-y) scenario seems to be quite puzzling if we compare the headline WPI inflation and CPI-IW inflation. The WPI inflation which is also the headline inflation has just emerged from a deflationary bout with inflation just hovering around 0.9% (October 2009) whereas the CPI-IW inflation has been hovering around double digit levels (11.72%, August 2009). The seasonally month-on-month (m-o-m) data provides much clearer scenario. There seems to be some sync in both WPI and CPI inflation rates in the last few months with both showing high inflation rates. But in the recent months this seems to be moderating. The rise in inflation has been mostly from supply side factors with moderate impact from the demand side. So hiking the rates would not have served the purpose.
 
The policy rates have direct implications on the real sector growth. IIP m-o-m seasonally adjusted growth rate and y-o-y growth has seen a pick from June 2009 onwards. IIP revival is a good sign for the growth of the real economy. However, in the m-o-m seasonally adjusted IIP growth rate we find some moderation in the last two months (July-August 2009) which doesn’t seem to suggest a strong recovery happening. The IIP from June 2009 onwards on y-o-y basis has been growing at an average rate of 7 percent. The robust consistent growth in IIP seen in the recent months has also led RBI in a way to raise it growth projections for the overall economy above 6% for the present year.
Overall the economy seems to be moving towards moderate growth track. The world economy seems to be on a recovery path too. The trade sector which is tied to the recovery of the world economy would take some more time to grow back to levels prior to the financial crisis. Investments in the economy seem to be picking and foreign inflows especially foreign institutional investors (FII) flows have been pouring in huge amounts. However, getting back to the 9% growth track would require some more time and this is where RBI has tried to exercise caution. The status quo maintained by RBI is the right policy measure as the economy has not revived fully with some sectors still struggling. However, in the forthcoming monetary policy review we can expect some policy tinkering on the upward side by the RBI. |
