The monetary policy stance articulated in yesterday’s quarterly announcement broadly lived up to expectations. The main policy instruments — the repo and reverse repo rates and the cash reserve ratio — were not changed. This was consistent with the Reserve Bank of India’s (RBI) view that, while the recovery was under way, it had not quite consolidated. Among other points of fragility is the agricultural situation, where this year’s output is expected to drop appreciably from last year’s. Consequently, the RBI has maintained its baseline GDP growth forecast for 2009-10 at 6 per cent, somewhat more conservative than those of the Ministry of Finance and the Prime Minister’s Economic Advisory Council. Since both those bodies, despite their greater optimism about growth, had already voiced their preference for the status quo, the RBI’s forecast provided an even stronger justification. Of course, inflation is a concern, something which Governor Subbarao has been voicing for the past several weeks, but he rightly decided to wait a bit until the balance between inflation and growth had swung a little more. However, beyond this, there were significant actions taken, which, while they will not materially impact banks and financial markets, clearly signal the end of “special circumstances”, which called for massive injections of liquidity. Towards this end, the RBI has raised the Statutory Liquidity Ratio back to its pre-crisis level of 25 per cent and terminated with immediate effect three special channels of liquidity enhancement it had introduced last year — for exports, banks and mutual funds. This, according to the Governor’s statement, should be taken as a signal that the stance has shifted from “managing the crisis” to “managing the recovery”.
By contrast, there were several significant measures taken at the market and sector level, which indicate that the RBI is pushing ahead with a broader financial sector reform agenda. Currency futures involving rupee-dollar transactions were introduced earlier this year; the scope of this market has been expanded to cover the euro, the pound and the yen, allowing participants to directly hedge exposures in these currencies. Simple, “vanilla” credit default swaps have been introduced, providing banks a low-cost way to insure their loan exposures. These instruments have been criticised as having contributed to the global financial meltdown. But, within clearly defined and enforced prudential limits, they sharply reduce the costs of managing risk. On financial inclusion, measures to expand the range of people who can be appointed Business Correspondents by banks, thereby increasing reach without much investment. Most significantly, a proposal endorsed by the Committee on Financial Sector Reforms to introduce tradable Priority Sector Lending Certificates, a measure that can significantly increase both the volumes and efficiency of priority sector lending, has been taken on board and a group has been set up to operationalise the scheme. There are several other announcements of this nature, pointing to the fact that even when there is little action on the macro front, the micro agenda remains both important and urgent.