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Meeting the global challenges

In its mid-term review of the annual credit policy, the Reserve Bank of India has emphasised liquidity management to maintain financial stability and keeping prices under check. Those have always been important objectives of the monetary policy but the context in which they are being addressed this time is significant. Barely four days ago the capital market regulator, SEBI notified new norms which are expected to moderate capital flows and improve their quality. The centr al bank elaborates on the need to manage capital flows and their attendant consequences for the domestic economy, going so far as to suggest that, at this juncture, it is the biggest challenge for monetary policy on the domestic front. Monetary authorities will also have to reckon with the developments in the financial markets abroad, where the twin crises in the United States’ housing and credit markets have caused a big upheaval that shows no sign of abating. Within India there has been a surge in liquidity caused by a hefty rise in foreign institutional investments in the stock markets. Money supply has grown at a higher pace and banks have mobilised more deposits so far this year. Even credit disbursements by banks, which were expected to slow down, have increased by a robust 23.3 per cent till October on top of a nearly 29 per cent rise last year. There has been a sharp escalation in asset prices, particularly real estate and equity.

In hiking the CRR by 0.50 percentage points, while leaving the repo rates unchanged, the RBI has left the task of setting interest rates to the banks themselves. The absence of more overt signals on interest rates is probably due to policy dilemmas that have always existed and are now exacerbated following the unprecedented capital inflows. A signal for higher interest rates may be desirable in the context of dampening inflationary expectations but it might encourage even larger fund flows into the country and push the rupee even higher. On the other hand, a lower interest rate may partly help in checking the rupee appreciation but it will further boost the already exuberant stock market sentiment. On inflation, the RBI is sticking to its target of 5 per cent for this year even though in recent weeks inflation has been on the low side. There are a number of factors that might derail the RBI’s inflation target and GDP growth projection, which is retained at 8.5 per cent. The mid-year review is focussed on likely threats to the Indian economy from abroad and, coming as it does soon after the SEBI moves, it is a major step forward in developing a holistic policy framework on capital inflows.

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