Maintain status quo

The Reserve Bank of India (RBI) will make its quarterly announcement of monetary and credit policy next Tuesday in the context of a rather complicated macro-economic environment. While the domestic situation looks relatively comfortable on the growth and inflation fronts, the global scenario remains full of uncertainties. A recession in the US is still a possibility, notwithstanding the Federal Reserve Board's reduction in the federal funds rate. This could mean slower growth for the rest of the world. Oil prices have zoomed recently. And, closer to home, the persistence of capital inflows is pushing the rupee ever higher. What does all of this mean for the RBI's decisions regarding its benchmark repo and reverse repo rates, and the cash reserve ratio (CRR)?

Two criteria are useful tools in this situation. The first is to act according to the indicators which are the easiest to interpret. The second is to focus on the objectives that are most likely to be attained as a result of actions taken (or not taken). With this in mind, the best course of action just now is to maintain the status quo. The main considerations justifying this come from the domestic indicators that are available for the second quarter so far. Industrial production took a dip in July, with a growth rate over last year of about 7 per cent, but recovered to 10.7 per cent growth in August. During the first five months of the year, it has grown by over 10 per cent, lower than last year's performance of over 12 per cent, but well within the range of expectations as far as response to recent monetary measures is concerned. Early corporate results from the quarter also suggest some loss of momentum but by no means a meltdown. And, the inflation rate has been particularly benign in recent weeks, having almost touched 3 per cent during the first week of October. Of course, this has been helped by both a significant decline in food prices and the complete absence of adjustment of domestic retail prices of petroleum products in response to the recent surge in the international market. However, even if this were accounted for, it is unlikely to take the rate outside the RBI's comfort level of around 5 per cent. In short, all indications are that this is a soft landing, playing out pretty much as the RBI might have anticipated when it embarked on its combination of rate and CRR hikes late last year. If that is indeed the case, there is no argument for applying the brakes any further.

This is not to under-estimate the significance of global developments or surging capital inflows. On the first, there is very little that the RBI can do in anticipation of how the situation might play out, so waiting and watching makes sense. The second raises the deeper issue of whether rupee appreciation should be resisted or allowed. Recent patterns suggest that the RBI has adopted a half-way house approach, having been given some room for manoeuvre by the low rate of inflation. The pros and cons of both courses of action have been intensely debated on this page; given the fundamental significance of the issue, it is unlikely to be addressed within the relatively routine confines of a quarterly announcement. But, clearly, it needs to be addressed quickly and explicitly.