A closer look at the policy statement, however, brings out several measures that augur well for the Indian economy. In fact, Governor Reddys first credit policy clearly indicates RBIs intention to move towards inflation targeting.
Looking at the direction of rates, the Governor is positive about inflation with the projected rate for the Policy being 4- 4.50 per cent against the 5.00-5.50 per cent projected earlier, with the bias being for lower rates. However, he has cautioned that the possible consequences of continued abundance of liquidity need to be monitored carefully. Having said that, the preference for a soft interest rate environment continues.
Given that the Liquidity Adjustment Facility is being reviewed, as is the corridor between Bank Rate and repo rate, it is possible that the use of Bank Rate might be demised. Thus, the RBI may be awaiting a better definition of the role for these rates prior to changing these rates.
Where the market was perhaps looking at a monetary response to the burgeoning forex inflows, the Governor has adopted a policy of continuity by stating that the exchange rate management is based, as in the past, on flexibility without a fixed or pre-announced target, but with RBIs ability to intervene. It seems likely that given the continuous change in the composition of the inflows from time to time, the RBI has possibly felt that any increased liquidity as a result of a reduction in the repo or Bank Rate may not put at risk the inflation numbers. The RBI has been saying that interest rate arbitrage flows have not been the dominant reason for the build up in reserves with that issue being tackled through a specific cap on interest rates on NRE deposits. Flows into the equity markets are not so readily amenable to monetary responses. The RBI has, therefore, directed its response on this issue to foreign currency loans being extended by Indian Banks and corporates would have to put in place a board approved policy for the hedging of these loans, with the onus being put on the lending banks to ensure hedging.
The Author is Country Head, HSBC India