Tamal Bandyopadhyay:Gamble on growth

A close look at two key structural shifts in Y V Reddy's policy statement.

India Inc heaved a sigh of relief; bulls were on a rampage on the Dalal Street and the bond market rallied to greet a radical shift in the stance of Reserve Bank of India Governor Yaga Venugopal Reddy's monetary policy. His preference is clearly tiled in favour of growth to price stability.

In his first policy statement in November 2003, when Reddy presented the mid-term review of monetary policy for the year 2003-04, he had said: "As has been the practice in the past and was emphasised by my predecessor Bimal Jalan, monetary measures have to be taken promptly and effectively, to respond to the rapid developments in both the domestic and global markets." There is no change in the underlying theme of the policy. Even now he is ready to respond to the evolving situation promptly and effectively. However, the bias in favour of growth is clearly spelt out in the 73-page document released on Tuesday. He does not want to rock the boat when the going is good. This is a very different Reddy who raised the reverse repo rate by 25 basis points in January ahead of the presentation of the Union Budget.

Ever since he has taken over as country's chief money man, Reddy's stance has been undergoing subtle changes in response to the domestic and global developments. He took over at a time when the key policy rates were ruling at their historic low level "" bank rate at 6 per cent and reverse repo rate (then called repo rate) 4.5 per cent. Jalan cut the reverse repo rate by 50 basis points in August 2003, just before Reddy took over. He had also cut banks' cash reserve ratio (CRR) by 25 basis points to 4.5 per cent releasing additional liquidity in the system in June 2003.

By the time Reddy moved to Mint Road, the world economic outlook improved, inflation outlook turned more benign and financial markets were stable. The only pocket of discomfort was tardy credit growth. Hence, Reddy did not deviate from the overall stance of the policy for 2003-04: a) provision of adequate liquidity to meet credit growth while keeping a vigil of movements in the price level and; b) preference of a soft and flexible interest rate environment within the framework of macroeconomic stability.

In May 2004, when Reddy announced his first annual policy, the first change in the stance was noticed. The bias for "soft" interest rates quietly disappeared from the policy document. The policy committed to provide "adequate liquidity to meet credit growth... while keeping a very close watch on the movements in the price level." It also stated that the RBI would "pursue an interest rate environment that is conducive to maintaining the momentum of growth and macroeconomic price stability." He left the repo rate untouched in May but raised it from 4.5 per cent to 4.75 per cent in October 2004.

The second time the repo rate was hiked during his tenure was in April 2005, when Reddy presented his second annual policy. By that time, non-food credit offtake got its momentum and the system recorded over 30 per cent credit growth. No wonder Reddy re-phrased his monetary stance by replacing the word "adequate" with "appropriate" while talking about availability of credit. So, his stance read: "Provision of appropriate liquidity to meet credit growth... while placing equal emphasis on price stability". The last year's policy also committed to "pursue an interest rate environment that is conducive to price stability... and maintaining the momentum of growth." Finally, it also proposed to "consider measures in a calibrated manner, in response to evolving circumstances with a view to stabilising inflationary expectations."

Two successive rate hikes took place in October last year as well as January this year. The quarterly review of credit policy in January not only raised the rate but also announced a change in the stance of the policy. First, emphasis on price stability and anchoring inflationary expectations turned out to be RBI's main agenda, pushing growth relatively low in the central bank's priority list. It also dropped clear hints that it was not happy with the unbridled credit growth. Its stance in January was "to provide appropriate liquidity to meet 'genuine' credit needs of the economy with due emphasis on 'quality'."

Bankers failed to take note of caution and focus on the quality of credit. So, the annual policy has completely done away with the customary commitment of providing adequate or appropriate "" as the case may be "" liquidity to meet the "credit" demand. Instead, it has talked about supporting "export and investment demand of the economy". The message is clear: It does not want the banks to chase retail credit and the banking system must focus on investment needs of India Inc. Reddy also backed growth more than stability at this juncture even though he promised to be ready to act in a "timely and prompt manner on any signs of evolving circumstances impinging inflation expectations."

There is yet another structural shift in the policy. All along, domestic developments have been influencing the policy stance in a major way while global factors have been looked into. This time, the RBI has given more weight to global factors. When central banks across the globe have been tightening the monetary policy, the RBI cannot possibly stay out of step for long.