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What underlay the monetary policy decisions announced by Reserve Bank of India Governor Raghuram Rajan last week? Most obviously, there must have been a concern for inflation - retail inflation, as Table 1 shows, has remained at or close to double digits for some time.
However, the RBI chose to ignore the sustained decline in other measures of inflation, particularly in wholesale prices of manufactured goods, which is now below two per cent.
In addition, the markets have been in turmoil and the policy announcement will have sought to calm them. The Sensex broadly declined after the RBI announced liquidity-tightening measures in July, and then recovered after Rajan's appointment as governor, as Table 2 shows.
A similar pattern is visible in the rupee in Table 3. Liquidity was volatile until those measures, as Table 4 shows - but has since appeared notably constrained at Rs 40,000 crore. Also relevant are government security yields.
As Table 5 shows, the RBI's measures raised yields on short-term government debt - and also on long-term debt. Further, Table 6 shows that the spread between Indian and US government's long-term debt had narrowed dangerously prior to the tightening of liquidity.
Finally, the RBI will have noted that credit growth appears to have picked up again as compared to deposit growth, as shown in Table 7. Higher deposit rates would be necessary to keep banks going. In terms of the real return on bank deposits, notably, India is not an outlier, doing at least as well or better than most major economies, as shown in Table 8.
