Amid growing exuberance over the economic outlook, the Reserve Bank of india strikes a note of caution in its Annual Policy Statement. It seeks to remind us of the risks that persist from unwieldy inflationary pressures and lingering uncertainties over the 'shape and pace' of the global recovery. While emerging markets seem to be going strong, these factors can leave the recovery vulnerable, justifying a calibrated approach towards monetary tightening.
Consequently, the central bank has raised the reverse repo and repo rates by a minimal 25 basis points, while implementing a quarter point hike in the cash reserve ratio, which tempers inflationary pressures and liquidity without compromising government and private borrowings. RBI is obviously in a tricky position, having to manage the exuberance without hurting business confidence. Inflation is still largely driven by supply constraints (following high food prices resulting from weaker output after the worst monsoon in nearly four decades), but demand pressures are kicking in. The wholesale inflation index has kept above the central bank's tolerance levels over most of the past year.
Liquidity, which tends to fuel inflation, is a supplementary challenge, as capital inflows to emerging markets pick up. Liquidity management is key and the central bank has been using the cash reserve ratio as a tool to contain liquidity, without impacting government and private borrowings.
A welcome move in the policy is the fillip to the infrastructure sector by allowing banks to hold investments in non-SLR bonds issued by the infrastructure sector in the held-to-maturity category and also reducing provisioning requirements for sub-standard loans to the sector. By reducing the provisioning burden on banks, RBI has made it far more attractive to extend funds to the infrastructure sector, among the most crucial sectors for growth.
On a different note, it is heartening to note that RBI has once again picked up the topic of foreign banks' presence in India. While at this stage it is not clear what the central bank has in mind, one can hope for a greater role by foreign banks, some of which have long-standing operations in India, are aligned to national priorities, and want to expand their product and servicing offering across the length and breadth of the country and across various customer segments. We look forward to the central bank's thinking on the subject.
