RBI lowers liquidity but leaves rates unchanged

The Reserve Bank of India announced its quarterly monetary policy today. It left benchmark rates unchanged, like the repo rate (the rate at which banks borrow from the RBI) and the reverse repo rate (the rate at which banks park their surpluses with the RBI. What it did was to hike the cash reserve ratio by a good 75 basis points, taking out Rs 36,000 crore from the banking system. Cash reserve ratio is the proportion of deposits that banks must set aside as a reserve. Apart from this, the RBI has not made any changes and the Annual Policy will be announced on April 20. Of course, the RBI has the prerogative to take measures before that too, if required. In the current policy statement, It has outlined its view on the monetary situation, which should give some idea of what to expect ahead.

What the CRR cut hopes to achieve: reduce excess liquidity to limit inflation expectations and move towards price stability without affecting the economic recovery process.
What is the RBI’s monetary stance for the last quarter? Keep inflation and inflationary expectations under control. Manage liquidity to ensure that adequate money is available for lending, but not so much that it encourages reckless behaviour. Focus on price stability (low inflation), financial stability (interest rates and exchange rate situation) and support the growth process.

Move from managing the crisis to managing the recovery: the RBI statement raised the need for monetary policy from its present position of managing a crisis to managing a recovery. This statement is critical for the RBI is explicitly making it clear that the time has come for the withdrawal of the monetary stimulus measures.
Inflation: though the current inflationary trends –particularly in food- are widely accepted as being supply driven, the RBI is also seeing demand-driven pressures. It fears that inflation can spill over from a few sectors into a more broad-based phenomenon which may become very difficult to control. The Indian economy growing is good news indeed, but the pace of recovery may lead to industries operating at full capacity and combined with rising global commodity prices and wages, may lead to higher product prices.

The RBI has outlined its concerns but has stopped short of taking any drastic actions. The reason is the Union Budget, due in a month from now. The bigger role lies with the government. The RBI makes this amply clear as it says that ‘a bigger risk (compared to inflation) to short term economic management and to medium term economic prospects’ is the ‘large fiscal deficit’. The measures that were taken during their crisis have served their purpose and the time has come for the government to indicate the roadmap to taking fiscal deficit back to the pre-crisis levels and how and when it will roll back the fiscal stimulus measures.

You can read more from the policy statement here, which makes for excellent reading, is written in simple language that anybody can understand. The document outlines the RBI’s view on various aspects.

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