RBI Stays on Course but Eases Liquidity

As the benchmark Consumer Price Index inflation stubbornly stood above eight percent coupled with the threat of El Nino to monsoon rains and the likely impact of geo-political tensions on fuel prices that can cumulatively push the inflation upward, the Reserve Bank Governor, Dr. Rajan, as anticipated, maintained the status quo on policy rates: Repo rate kept unchanged at eight percent; reverse repo at seven percent, and cash reserve ratio at four percent.

The Governor has, however, simultaneously taken a number of steps that gives a feeling of easing in his policy stance signaling that the scenario is all set to return to normal. He has reduced the Statutory Liquidity Ratio—mandatory investments in government bonds—by 0.5 percentage point to 22.5 percent of banks’ net demand and time liabilities. He thus made an additional liquidity of around Rs. 40,000 cr available to the banking system for their quick lending, should growth in economy pick up momentum.  Secondly, this move also curtails government’s access to bank funds which may in turn contain fiscal deficit. 

On the external front, the RBI has reduced the export credit refinance from 50% of eligible export credit outstanding to 32% with an offsetting introduction of a special term repo facility of 0.25% of deposits. Outward capital flow limit that was reduced when Rupee was passing through a turbulent phase has been partially restored: Liberalized Remittance Scheme (LRS) is now raised to $1,25,000. Simultaneously, Foreign Institutional Investors are now permitted to hedge their rupee exposure in the domestic derivatives market, signaling that all is well with the rupee. 

There is thus nothing much in the second bi-monthly monetary policy of 2014-15 that could surprise the market except for the Governor’s policy statement on inflation which sounds pretty optimistic: “if economy stays on course, further policy tightening will not be warranted and …headroom for an easing of the policy stance.” Reading between the lines, one could, of course, say that Dr. Rajan has for the being succeeded in  balancing  both the inflation and growth objectives, while of course, waiting for the final cues from the budget of the new government.  Indeed, that’s what even the Finance Minister, Arun Jaitley, said: “…It has followed a calibrated approach aimed in the direction of balancing between growth and inflation”.

Now, it is for the government to come up with such measures which lead to fiscal consolidation and increased food supply so that disinflation process picks up momentum paving the way for easing of interest rates. In this regard, it’s of course, heartening to hear Jaitley saying, “Fiscal consolidation is a priority for the government.”  The new government must simultaneously think of releasing food grains from its holding into markets across the country, for this shall lead to fall in food prices which are indeed the main culprit in the present inflation spiral.  Then, initiate steps to urgently build the required infrastructure for better storage of food grains and their processing for efficient marketing.

This is indeed what the RBI governor perhaps meant when he invoked Japanese Prime Minister, Shinzo Abe’s “three arrows”—monetary, fiscal and economic strategies to boost the economy. And, encouragingly, it is perceived all around that today the entrepreneurial spirits are at their best in the country and hence decisive decisions by the new government will help revive growth in economy. Therefore, what the government must do now is: act quickly and act rightly.

It is needless to say here that a good understanding and a healthy relationship between the government and the Reserve Bank is the prime prerequisite for reviving the growth in the economy. Unlike in the previous regimes, the government and RBI should now work in tandem to deliver what the country is expecting from its new government.