Holding operation

This year's monetary policy announcement comes when several risks loom large on the horizon.

Portfolio flows to emerging markets have reversed, oil prices have crossed $40 a barrel, the US Federal Reserve has indicated that it will raise interest rates soon, and the dollar has regained some of its strength.

The influx of large doses of foreign funds had been the defining feature of the markets last year, with stocks, bonds and the rupee all gaining from the inflows.

While stocks gained the most, the supply of dollars led to the rupee appreciating, and the Reserve Bank of India's policy of mopping up dollars led to a surge in rupee liquidity, pressing down interest rates in the bond markets.

These trends are now in danger of reversing, which is why the RBI's stance on monetary policy was keenly awaited.

Perhaps more importantly, this year's policy has been announced against the backdrop of nervous and volatile stock markets, and a tightening of policy by the RBI would have dealt yet another blow to the market. Putting it bluntly, this would have been the worst possible time to announce a change of stance.

Thankfully, however, the RBI has acted responsibly, preferring to keep its stance unchanged, while pointing to the uncertainties in the current environment. It has pointed out, for instance, that rising global interest rates could have "significant influence on capital flows to emerging markets".

It points to the high oil prices, the fluctuations in currencies and the risks of inflation, but merely advises market players to be aware of the risks and hedge against the uncertainties.

At the same time, the central bank loses no opportunity in driving home the strong fundamentals of the economy. It says that the Indian economy will continue to be one of the top performers globally, and draws attention to the structural changes in the economy that are conducive to higher growth.

It believes that in spite of the uncertainty about oil prices, the rate of inflation this fiscal will be around 5 per cent. It points to the IMF's higher forecast for global growth, while it cautions against the imbalances.

On the all-important question of foreign inflows, it points out that the current account is in surplus in spite of a widening trade deficit, thanks mainly to more remittances from non-residents.

Doing a fine balancing act, the central bank says that while domestic factors indicate stability, there's greater potential for monetary tightening in the advanced economies.

In short, the RBI is saying that at the moment it doesn't want to disturb the status quo. That's understandable, given the uncertainties in not just the economy but also in the political environment. It's difficult for the RBI, for instance, to formulate monetary policy without having an idea of the fiscal policy stance of the incoming government.

Similarly, the new government's stand on administered interest rates needs to be known. Under these circumstances, all that the RBI can do is push ahead with its policies of tightening prudential norms and enhancing the flow of credit to sectors such as infrastructure, while continuing with technical improvements in the debt markets, and this is precisely what it has done.

Simply put, this policy statement is merely a holding operation, with the significant policy changes likely to happen once there's clarity on the political and fiscal fronts.