And now, quarterly guidance

RBI ANNUAL POLICY 2005-06

A stitch in time saves nine. No one knows this better than the Reserve Bank of India governor Yaga Venugopal Reddy. Instead of being hemmed in by the market, he has once again led the market on the interest rate front with a 25 basis points hike in the reverse repo rate.

Instead of waiting for the inflation rate to rise and then swing into action, Reddy has done what any prudent central banker would have done: Hike interest rates now and douse inflationary expectations.

An equally important change has been to double the frequency of monetary policy guidance. From just two annually, there will now be quarterly announcements of the monetary policy stance, with the next one slated for July, 2005.

Of more immediate impact is the rate hike. Wearing his other hat as a merchant banker to the government, Reddy could have chosen to wait for a more opportune time to hike rates after watching developments on the monsoon and oil price fronts.

In fact, finance minister P Chidambaram possibly wanted the Indian central bank to act this way. After all, when rates go up, the government, as the country's biggest borrower, is the biggest loser. But had Reddy paid more heed to the government's short-term needs, he might have had to opt for a much sharper rate hike in his next policy.

In November 2003, when Reddy announced his first credit policy as Governor, bankers expected a cut in interest rates. But at that time he had refrained from doing so as that was just the beginning of the turn in the interest rate cycle. Had he opted for a cut at that time, it would have necessitated a sharper policy reversal later.

So, he did not do so and waited for a year to hike the rate in October last year. Thursday's reverse repo hike is his second dose and he could well opt for more such hikes in future if the situation warrants.

However, the bank rate "" the main signalling rate under his predecessor Bimal Jalan "" has remained untouched. This is because in a liquidity-surplus situation, it is the rate at which liquidity is sucked out of the system (that is, the reverse repo) that is important and not the rate at which liquidity is injected. If liquidity tightens and inflation rates go up, Reddy will probably go for a hike in the repo rate as well.

The reverse repo hike apart, Reddy has also addressed a string of structural issues ranging from credit delivery to market reforms. However, the most important change he has ushered in is in the institution of credit policy itself.

Bimal Jalan had almost made the biannual policy a non-event by making all relevant monetary announcements outside the policy platform. Reddy now has gone the other way and promised to policy guidance a quarterly event.

Besides the annual policy in April and a mid-year review in October, there will be two quarterly reviews in July and January. So, from now on we will have quarterly guidance on the economy from the Indian central bank.

This will give the RBI an opportunity to review its stance and take appropriate monetary measures in shorter intervals in response to the changing dynamics of the global and domestic economies.

In essence, the RBI is positioning itself like the US Federal Reserve. The Federal Open Market Committee (FOMC) meets eight times a year to review the macroeconomic situation and decide on the appropriate stance of monetary policy.

Between June last year and now, the FOMC approved seven hikes in the US Fed base rate "" from 1 per cent to 2.75 per cent. The minutes of FOMC minutes are released a few weeks after the event.

The Bank of England makes public the voting pattern of its central board members on any interest rate hike proposal. The RBI will take time to emulate those examples. But it has made a small beginning in that direction. In that sense, it's a landmark policy.

Click here for the Annual Policy Statement for the year 2005-06