Reddy Blends Caution With Optimism

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: Governor YV Reddy’s Annual Policy Statement for 2004-05 of May 18, 2004 could not have faced a more difficult backdrop.

1. While skeptics could label it as colourless, the statement reflects a remarkable degree of prescience. As Lata Venkatesh said on CNBC immediately after the policy announcement, the 66-page printed statement could not have been a postscript to the stock market carnage of May 17, 2004. Yet, in many ways, the policy announcement has been so well crafted that one almost believes that it was prepared taking into account events which could not be foreseen.

2. The policy makes a forthright statement that it is essential to pursue fiscal consolidation promptly. It emphasises that excess holdings of securities by banks far exceeds the annual borrowing programme.

3. The statement puts paid to wishful thinking of 8-10 per cent real gross domestic product (GDP) growth rates, at least for 2004-05. The Reserve Bank of India puts forth a sensible 6.5 - 7.0 per cent growth rate for 2004-05 and rightly explains that in the context of the 8.1 per cent growth in 2003-04, reflecting the recovery of agriculture, the 2004-05 projection should be considered as good and in an international context should be considered as superb. The policy also cautiously estimates inflation in 2004-05 at 5 per cent in view of international oil and commodity price increases.

4. While some analysts would latch on to the phrase "soft and flexible interest rate environment", in fairness to Governor Reddy he has clearly set out the risks in the system. He refers to the global implications of interest rate uncertainties and their impact on capital flows and that Indian participants in financial markets are advised to be vigilant (Paragraph 37). He refers to the inevitable implications of the external sector for the conduct of domestic monetary policy and exchange rate (Paragraph 46). He warns that geopolitical uncertainties on the international oil economy are not waning (Paragraph 59).

While recognizing that interest rates in India may need to rise because of global factors, increases at this stage may not be apposite because of the nascent domestic recovery (Paragraph 62).