On balance, do nothing

The Reserve Bank governor will present tomorrow his credit policy for the next half-year. In essence, he does not need to do anything at all, other than to say that he is keeping a watchful eye on developments.

For, although the macro-economic context has changed somewhat with slightly tighter liquidity and faster-than-expected credit growth in recent months, there is no real reason just yet to use any of the levers in the governor's hands.

Liquidity still remains comfortable, the inflation picture is broadly unchanged, the economy continues to grow at the same speed, oil prices are where they were six months ago, and despite all the worries about the US economy's macro balances, the external environment is still benign.

It is of course true that the inflow of dollars has eased. And on the inflation front, an upswing in prices must result whenever petro-product prices are raised to reflect market reality.

But equally, there is still a net inflow of foreign exchange and no sign of domestic over-heating.

It could be argued therefore that, in the totality of the situation, the 1.5 percentage point increase in interest rates on 10-year government paper over the past year reflects adequately the change in the credit environment, and there is no need for the RBI to signal further changes.

That is not to say that there is no scope at all for anticipatory action.

The most important argument in favour of adjusting gears would be the government's borrowing programme, which the RBI has to manage and which is beginning to look like a challenge, both because the size of the programme has expanded sharply from last year and also because of the slight tightening of liquidity in the money market.

A supplementary reason for wanting to raise domestic interest rates would be that US rates have gone up since the last credit policy announcement of October.

It could be argued, therefore, that Dr Reddy should signal these environmental changes with a marginal tweaking of interest rates by no more than 25 basis points, if nothing else then as a signal to the markets.

There is no strong argument against such a marginal step, as it would not upset any apple-cart and would certainly not be enough to change corporate calculations to any noticeable degree.

On balance, though, the current liquidity situation is such that this step is not really called for and the governor can get away with benign inaction.

Dr Reddy could profitably spend his time, therefore, dwelling on a series of other issues that demand attention. One is the urgent need to develop a proper debt market, an issue on which RBI has always dragged its feet""perhaps because of its innate and longstanding suspicion of the players in the money and currency markets.

Another is the banks' state of readiness in relation to new international norms that they will be expected to meet. And a third is the cooperative credit structure, where there have been the stirrings of corrective action but no fundamental moves to change the rules.

Finally, the governor could usefully tell the government, and not just in private (he must have done already), that the failure to control the fiscal deficit is about to take a toll on the economy.