The stance of the policy suggests that the RBI is concerned both with rising inflation pressures as well as overheating in certain sectors that could manifest in declining asset quality. It has chosen to tackle the inflation problem by raising the cost of funds in the system and clamping down on liquidity inflows. Thus, apart from the repo rate hike the RBI has also lowered the ceiling on NRI loans to reduce the interest differential that encourages these inflows. It has chosen to address its sector-specific problems through more focused measures and not rely entirely on a blunt instrument like the repo rate. Going forward, we are likely to see more of these initiatives if these sectors do not cool down significantly.

The absence of any initiatives on the SLR front is a trifle surprising. While the markets and banks had not expected an immediate cut in SLR, given the concerns on inflation, it has certainly expected some direction from the central bank for the medium term. This expectation had actually led to some tightening of medium- to long-term yields and helped in the transmission of monetary impulses from the short end to the longer duration segments of the yield curve. This could reverse now. It is interesting to see that the RBI has explicitly specified its medium inflation target as 5%. This should help clear the confusion in the market about how much more the RBI will continue to tighten the monetary levers. A 5% target is fairly liberal and could be achieved with one more round of policy rate increases. One interpretation of this could be that the central bank is beginning to recognise the fact that a runaway rise in interest rates could impact growth by much more than is desirable.