The policy highlights the tough act that the apex bank will need to follow to achieve its twin objective of maintaining price stability and ensuring adequate flow of credit to productive sectors. With inflation rate hovering above 7 per cent, a sharp pick-up in credit, over 50 per cent of government's gross borrowing still to be tied up, a recovering global economy and surplus liquidity of Rs 680 billion, the review rightly states clearly that while RBI will attempt to maintain stability, markets should be prepared for uncertainties.
The governor points out that the most striking feature during the year has been the surge in non-food credit during the 'slack season'. While a welcome sign in itself, continued demand for credit coupled with a large borrowing programme in a high inflation scenario is likely to see a gradual firming up of rates.
The review has been used extensively by the governor to state clearly that the RBI will not hesitate to take steps to moderate inflation and inflationary expectations. The CRR hike effected in late September has been explained to be more towards this end then to drain out liquidity.
On the inflation front, the governor repeated that much of the spike is on account of supply-side factors.
At the same time, our interpretation of higher risk weightings prescribed for housing and personal loans is that this is a tacit admission that there are pressures on demand side and this is a warning shot across the bows of the more aggressive lenders, particularly as this is described in the policy document as a temporary counter-cyclical measure.
There are some welcome administrative measures also such as the review of CAR mechanism and establishment of a Basel-II steering committee along with continued reforms such as increasing limits for forward contract bookings by importers and exporters.
So far as the increase of 25 bps in repo rate is concerned, it seems to be more in the nature of an insurance plan.
It indicates once again that RBI is serious about not letting inflation expectations get out of hand, while indicating to industry and the government that maintaining conditions that support growth is very much on its agenda as well.
The fact that government security yields are already 150 bps higher than their lows and that call money rates are above the new repo rate makes this move less unfriendly than might have been the case.
In any case, the market seems to have been expecting either a small hike now or the prospect of a hike after 2-3 months. To that extent therefore, market yields are not expected to react sharply.
The governor has promised to provide appropriate liquidity and pursue interest rate environment that is conducive to price stability while maintaining the momentum of growth.
Decisions by the US Fed, crude oil and commodity prices and fiscal discipline exhibited by the government will tell us whether this is indeed deliverable.
