Relief all round

The Reserve Bank's annual policy delineation has managed to do two contrary things at the same time. It has used inaction quite effectively in the key area where tough action had been feared""further hikes in interest rates and tightening of liquidity. On the face of it, the decision not to change any of the key rates indicates that the central bank has heeded arguments that further hikes and liquidity tightening will not serve the intended purpose of reining in prices. However, the fact is that a key monetary tightening decision taken earlier, raising the cash reserve ratio to 6.5 per cent, comes into effect only next week. Also, the last round of interest rates was only four weeks ago, and another shock in this area would have been counter-productive. In any case, the central bank can afford to wait and watch. If the further impounding of bank deposits next week does not produce the required results, then the bank has time to take the next step. Indeed, the policy statement bears evidence that the central bank continues to keep its finger on the trigger. It has reiterated its over-arching goal of maintaining price stability and inflationary expectations, and promised to act swiftly if prices rise further. More, it has lowered the inflation band that it is prepared to live with. It has also called for maintaining credit quality, thus frowning upon lending that accentuates asset bubbles and lowers the quality of banks' assets. The stock market has greeted this temporary let-off with a sharp spike but that may also be a natural correction process after the negative sentiments of the last couple of days and the need to cover short positions.

What is interesting is that the inaction on rates has been combined with extensive action to take the rupee further down the road to full convertibility""all of which also helps neutralise partly the capital inflow, which has become an important source of fresh liquidity in the system. Even if the real motivation is defensive, it is impressive to see how much has been initiated and signalled at a time when there was a fear that the window for external commercial borrowing would be partially closed so as to slow the inflow of capital. The only place where the RBI has partially closed a window is by lowering further the interest rates that can be offered for non-resident Indian deposits, in a move to squeeze out the inflow that is considered the most volatile. The opening up, in comparison, is across the full range of market players. Companies can now invest more abroad and pre-pay their foreign currency borrowings freely up to a higher limit; smaller firms can enter into foreign currency transactions without actually completing the underlying business transactions; and mutual funds can invest more abroad. But in terms of the impact on public perceptions, the announcement that matters most is doubling the ceiling on what individuals can remit abroad through permitted transactions, to $100,000. And the signals are that more opening up is on the way, as working groups have been announced to go into the development of interest rate futures and currency futures.

The broad thrust of action on the future of foreign exchange control is clear""and has probably been driven primarily by foreign exchange reserves crossing the $200 billion mark and by the problems involved in sterilising fully the net inflow that is there. That is why the RBI has stopped trying to keep the rupee within the band dictated by inflation-adjusted rates against the major currencies. In other words, necessity has become the mother of currency reform.