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Price stability the key objective

All major monetary aggregates are projected to grow at a slower rate this year

DESPITE INFLATION remaining the key concern, the Reserve Bank of India, in its annual policy statement released on April 24, made no changes in its policy rates or reserve rates. However, the absence of any hikes in the bank rate, the repo rate as well as the cash reserve ratio (CRR) fits into the recent pattern of credit policy pronouncements, whose chief characteristic has come to be the avoidance of sensationalism. Also, there was no need to change either the policy rates or the reserve rates while releasing the annual policy.

Since December last year the RBI has been aggressively tightening monetary policy through a series of hikes in repo rates and Ceramist of these were announced outside the policy pronouncements. On January 31 while reviewing the monetary policy for the third quarter of 2006-07 the RBI did effect hikes in the repo rate. The last variation in the CRR and the repo rate was made only at the fag end of last year. Three weeks on there was perhaps no need to signal still higher rates but the RBI reserves the right to vary the rates as and when necessary. So what is special this time?

The credit policy statements are watched closely for what the RBI says on the macro economy. With a GDP growth forecast for 2007-08 at 8.5 per cent, the RBI expects inflation to be contained close to five per cent. Last year (2006-07) it had fixed a target range for inflation at between 5 and 5.5 per cent, which, as everyone knows, has been breached, necessitating the several monetary packages.

Growth estimates

The Bank's growth forecast for last year at eight per cent has been, with the wisdom of hindsight, too conservative. CSO's estimates place it above 9 per cent. Great significance is attached to RBI's growth forecast. This year (2007-08) is the first year of the XI Plan which targets an average growth rate of 9 per cent. The reasons why the RBI is again seen to be cautious are not far to seek. The global economy, according to most forecasts, is expected to slow down. Second, the various inflation containment measures of the recent past take time to impact. A trade-off between growth and price stability seems imminent although many continue to maintain that it can be minimised if not avoided altogether.

All major monetary aggregates, the broad money supply, bank deposits as well as non-food credit are projected to grow at a slower rate this year. The last, credit growth, is expected to decelerate. Having grown by almost 30 per cent on an average during each of the three years between 2004 and 2007, it is expected to increase by around 24 to 25 per cent. Higher lending rates of banks might be the one major disincentive for borrowers. The RBI had also made certain types of loans more expensive by tightening the provisioning requirements that banks have to make. In the annual statement there has been a slight relaxation for residential housing loans up to Rs. 20 lakh. These would become cheaper but all other categories of loans, which were targeted by the RBI, will remain expensive to borrowers.

Appreciating rupee

Days before the credit policy announcement there was a renewed interest in the rupee-dollar exchange rate. The rupee, appreciating sharply broke multi-year records. Equally widely commented upon was that the RBI did not intervene aggressively as it used to. Is the stronger rupee a harbinger of major policy changes? Many observers had prematurely concluded that the exchange rate policy fuelled inflation .The argument is based on the fact that the RBI buys up the abundant dollar supplies and releases rupees which go to augment existing liquidity. At the next level, therefore, the central bank intervenes to sterilise the rupees through open market operations. According to this view the RBI should let the rupee find its level, that is, appreciate. Imports will become less expensive and the RBI need not resort to a cumbersome two-stage operation to neutralise the impact of continuing dollar inflows.

That argument has been faulted on a number of grounds. Exporters have been complaining recently and they have a point. A large part of merchandise exports is made up of manufactured items that are labour intensive. A setback in exports might have serious repercussions on the employment front. But, a large part of exports use imported items which will cost less as a result of appreciation of the rupee. Hence there is no question of viewing the impact of rupee appreciation on imports and exports as if they are watertight compartments.

On the eve of the credit policy announcement, there was intense speculation as to what steps the RBI will take to check dollar inflows? There was a talk that it might tighten access to euro currency borrowings As it turned out, the only disincentives that were introduced have been in the area of non-resident Indian deposits. But there are substantial steps in the direction of a fuller convertibility of the rupee. Resident individuals and companies have been given greater access to forex resources.

Indian companies can invest abroad up to 300 per cent of their net worth. They can prepay loans raised through the external commercial borrowings (ECB) route up to $400 million without RBI approval. Individuals can remit substantially more on account of any current account or capital account transaction. The new limit of $100,000 is double the earlier $50,000.

The above along with a greater leeway being allowed to domestic mutual funds in investing abroad are measured steps in the direction of full convertibility of the rupee. They also reflect the growing confidence in the external account, with forex reserves touching $200 billion recently.

C. R. L. NARASIMHAN

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