A monetary juggle

The Reserve Bank of India (RBI) is clearly in no mood to loosen its current tight monetary policy stance. An indication of it came from the Deputy Governor, Dr Subir Gokarn, who, on Saturday, made a distinction between the central bank's ‘monetary stance' (a view on the cost of money) and its ‘liquidity stance' (a view on availability of money for genuine productive use). The RBI, it would seem, is prepared to be accommodative of the latter, given tightening domestic liquidity conditions. Leaving aside for the moment the broader question of whether the RBI can, if at all, isolate the effects of its injection of liquidity into the system from the impact on the cost of funds, its latest observation has a practical dimension. The RBI's forthcoming mid-quarter policy review on December 16 is unlikely to see any reduction in its repo (lending) rate or even the cash reserve ratio (CRR) requirements for banks. The central bank's daily purchases of securities in ‘repo' auctions, besides outright open market operation (OMO) purchases since mid-November, have been somewhat successful in addressing the liquidity problem. Yields on benchmark 10-year government paper have fallen from 8.9 to below 8.7 per cent in the last 10 days.

Dr Gokarn's observations would, nevertheless, come as a disappointment to the markets that were seeing the RBI's resort to OMOs, after nearly a year, as a precursor to an easing of its monetary policy. A one per cent cut in CRR — the proportion of banks' deposits compulsorily kept with the RBI — seemed a logical next step, as it would have freed up about Rs 80,000 crore of lendable funds even without involving a lowering of the central bank's own policy rates. A CRR reduction looked all the more likely in the light of the People's Bank of China's recent move in this direction. But all these hopes have now been dashed, with Dr Gokarn saying that any action on CRR would “straddle the divide between liquidity and monetary management, which, at the current juncture, we are intent on maintaining”. This was as opposed to OMOs that do not entail a “change in any policy stance, real or perceived”.

That raises the question of how effective this conservative monetary stance would be, going forward. If the past is any guide, the outlook doesn't seem promising. Since March 2010, the RBI has hiked its repo rate 13 times by a cumulative 350 basis points. Yet, the wholesale inflation rate has remained at over 9 per cent since December 2010 and above 8 per cent from January 2010. The interest rate increases have, however, hit investment — as confirmed by the Government's own GDP data for July-September — by eating into the profits of firms and disincentivising them from augmenting productive capacity. In the process, they may have undermined the RBI's own battle with inflation.