Policy pivoted on forex stabilisation

Written by R Shankar Raman | Updated: Oct 31 2007, 07:10am hrs
The RBI continues to re-emphasise its policy preference to maintain price stability and well-anchored inflationary expectations. However, given the sudden spurt in capital inflows beyond absorptive capacity, the near term policy focus remains centred on forex stabilisation. Hike in the CRR by 50 basis points, a move intended to contain the surplus liquidity in the system, was in line with market expectations.

RBI should be commended for not altering the policy rates at this juncture. Upward price pressures remain quite significant in India with supply side constrained by 4-5 consecutive years of above trend growth. Inflation could also accelerate towards the year end on less favourable base effect and intensifying demand pressure following the recent easing of lending rates. Incomplete pass through of international prices of crude, metals, food commodities in general to consumer prices is indicative of suppressed inflation which carries destabilising potential into the future.GDP growth forecasts have been retained at 8.5%, assuming no further escalation in international crude prices and barring domestic or external shocks of significant magnitude.

It appears that the excess demand pressures has moderated, which leads us to believe that the RBI has reached the peak of its interest rate cycle. Interest rate hikes done in the past targeted at dampening domestic demand has achieved its intended purpose. It is quite possible that holding interest rates at these levels for some more time against the back drop of rate cuts by developed countries could potentially attract more capital inflows, reducing the efficacy of monetary policy tightening by expanding domestic liquidity.

Development of the corporate bond market is an urgent necessity, and RBI expressed its commitment for permitting market repos in corporate bonds. Thus, balancing growth and inflation is going to be a key challenge for RBI, going forward.

The writer is executive VP, L&T