Some key macroeconomic numbers should be flagged before analysing RBI?s annual policy statement for 2008-09 announced on Tuesday. India?s GDP growth in 2006-07 was 9.6%. In 2007-08, it was 8.7%. The range now forecast for 2008-09 by RBI is 8.0-8.5%. Wholesale price index year-to-year inflation stood at 7.4% at the end of March 2008. RBI?s inflation target for 2008-09 is 5.5%. Money supply (M3) increased by 20.7% in 2007-08. The target for this fiscal is now set at 16.5-17.0%. In March 2008, the average deposit rate was 8.00-9.25%, and prime lending rate was 12.25-12.75%. Moreover, the average yield on government securities was 8.12%. Now, take foreign exchange reserves?2007-08 saw an addition of $110.5 billion. What these numbers don?t make obvious, but is relevant to the discussion, is the fairly well-known litany of global problems that forms the backdrop of this monetary policy. The central bank?s statement isn?t about rates alone, and proposed reforms in financial markets, credit delivery, prudential measures and institutional developments, therefore, deserve to be commended. However, what invariably attracts attention is any change in rates. The bank rate, reverse repo and repo rates may have been left untouched, but RBI?s hike in the cash reserve ratio (CRR) to 8.25% was rather unexpected, since this ratio was increased by 50 basis points only recently. This move may have been triggered by bond redemptions expected on May 4, which could partly neutralise the earlier CRR hike. But beyond kneejerk reactions, the overall policy approach remains unclear. For a start, RBI is less than accurate when it suggests central banks worldwide are evenly divided across those which have cut rates, left them intact and tightened policy rates.

Most, or most important ones, are arrayed on the side of rate cuts, including the US Federal Reserve, which might even reduce rates further, shortly. This increases international arbitrage opportunities and stimulates capital inflows. Had RBI allowed the rupee to appreciate, which would have also helped control inflation, there wouldn?t have been the overhang of liquidity that RBI has flagged. The prime culprit behind excess liquidity is RBI intervention in the forex market to prevent any exchange rate appreciation, amid rising sterilisation costs (and falling efficacy of the same), compounded by RBI?s preference for acting as a public debt manager rather than a monetary authority. It is bad enough that fiscal problems constrain the ability to act against inflation. If inflation is due to supply-side pressures, including global phenomena, as RBI admits, then monetary policy is rendered largely useless, and the target of 5.5% inflation is a pipedream.

But the more worrisome part is this?in the process of explicitly reducing money supply growth, RBI could be crowding out both private investment and consumption expenditure, and this interest elasticity is a fact RBI itself admits, notwithstanding a slight revival in recent figures on industrial growth. Consequently, the growth forecast of 8.0-8.5% for 2008-09 also seems over-optimistic. Indeed, given the kind of monetary squeeze RBI seems intent on applying, it is a surprise why its number crunchers didn?t wonder whether GDP growth at projected levels can be consistent with projected and considerably lower money supply growth rates. Also, keep in mind that when credit supply gets squeezed, the credit distribution impact is often disproportionate. By relaxing asset classification norms for infrastructure lending, RBI is saying it has paid attention to a key component of credit distribution. But the issue goes beyond making lending for infrastructure, or for some categories of home loans, slightly easier. When credit is in smaller supply, bluechip borrowers suffer less. That?s not in consonance with India?s precepts of political economy, which require entrepreneurship to be encouraged at all levels. The poorly told story of RBI?s credit hardening has been the impact on private business outside the exclusive confines of India Inc.

The elephant in RBI?s monetary policy room continues to be rupee appreciation. It is something of a wonder why the central bank won?t allow rupee appreciation to act as an anti-inflationary measure. As our columnists in the pre-credit policy commentary series argued, it is not India?s external demand (exports) that need nurturing right now, but domestic demand. Letting the rupee rise would have allowed the central bank to encourage domestic demand. Still, the stockmarkets are happy that RBI didn?t increase policy rates. But what the central bank can do through the price of credit, it can also attempt via the quantity of credit in the system. And what it is attempting via quantity of credit is not consistent with what is doing in its exchange rate policy. The economy deserves a better monetary policy than this.