T.V. Gopalakrishnan
The monetary policy announced by the Reserve Bank for the second quarter is on expected lines.
In the context of a mixed backdrop of persistent sluggishness in advanced economies, positive signals of growth in developing economies, continued inflationary pressures in domestic economy and the need to maintain the trajectory of GDP growth in the region of nine per cent, the Reserve Bank has very limited choice to venture into any dynamic policies although the inflows of foreign exchange continue to disturb the exports, exchange rate, current account deficit, money supply, inflation, liquidity and interest rate and demand a separate treatment.
Growth of economy
Earlier, measures and professional approach of the Reserve Bank have paid off very well in ensuring steady growth of the economy at around 8.5 per cent. It may even cross nine per cent by March 2011 provided industrial, export and import growth maintain the present trend.
Even agricultural production can be better in view of the favourable monsoon this year. The non-food credit pick-up has been on the projected lines at around 20 per cent and would continue to persist/improve further.
Consumer confidence index
The consumer confidence index has placed India in a strong position (India's index points 129 for the April – June quarter) and this should help the industry, particularly consumer durable industry, to perform well. The money supply has been well contained within the projected level and at the same time, by and large, adequate liquidity has been maintained in the economy. Base rate system, replacing BPLR introduced with effect from July 1, has more or less stabilised indicating effective transmission of the Reserve Bank's measure in the credit market.
RBI steps to curb inflation
However, the concern of the Reserve Bank to contain inflation continues and the measures announced in the present review are well aimed at bringing down the inflation to around 5.5 per cent. But, unfortunately, inflation control in the economy is dependent on several factors which inter-alia include the inflows of foreign exchange on which the Reserve Bank has only limited control.
The quantitative easing in advanced economies has of late been unpredictable and the interest rate scenario in international market has reached its lowest ebb forcing investors to look for greener pastures in developing economies and India is a better destination due to its political and economic stability.
The flow is more on account of international economic scenario and unless and until the advanced economies recover and their interest rates tend to be attractive, the inflows will continue to be there.
Although the funds are welcome, the speculative nature of inflows can destabilise our system and needs to be tackled with some innovative measures.
The need to counter FIIs' dominance over the domestic capital market is the need of the hour and the present policy review has not come out with any measures to prevent undesirable inflows. Inflation being caused on account of such inflows in particular is somewhat difficult to contain as the normal approach of intervention in forex market and resorting to sterilisation measures have their own limitations and cost to the economy.
This dilemma of the Reserve Bank is a reality in the present scenario of domestic and international economic situation.
The financial position of the Government has improved considerably and this should give the Reserve Bank lots of comfort.
The fiscal deficit will be well within the budget estimate in the context of large spectrum auction realisation, improved tax revenues, significant inflows from disinvestment and reduced market borrowings.
Repo rates hike
The increase in repo and reverse repos rate by 25 basis points each will make the funds costlier i.e., only to check inflation growth but not to affect economic growth adversely.
The fact that the cash reserve ratio has not been touched will ensure continued availability of reasonable liquidity.
However, the deposit growth, which continues to lag behind, will have its own consequences on banks' funds position and needs to be tackled.
Deposit growth
The Reserve Bank's observation that the real rate of interest continues to be negative despite hike in deposit rates on account of high inflation and diversion of deposits seeking higher rate of return from alternative investments in gold, real estate, stock market etc. takes place needs to be seriously viewed and action initiated to arrest this trend.
The stake is very high for the economy as there is already a boom in real estate, gold and stock market prices. The abnormal increase in prices in these assets should not be construed to mean by any means the strength of the economy.
This has been adequately cautioned by the Reserve Bank and some measures in the housing loan segment have been proposed.
The prices should really reflect the fundamentals of the economy, purchasing power of the large segment of the population and the demand and supply of assets. The monetary policy of the Reserve Bank alone cannot be a panacea for the problems the economy faces.
(The author is former Chief General Manager, Reserve Bank of India.)
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