The liquidity augmenting measures included a 175-bps cut in CRR, 100 bps of reduction in SLR and raising of export refinance limits. Comfortable liquidity has enabled an efficient transmission through a decline in short-term borrowing costs by about 200 bps.
In the run up to the second quarter review of monetary policy 2012-13, the macroeconomic report released by the RBI a day earlier had two distinct messages. First, that outright monetary easing (read: cutting repo rate) may have to wait a little longer given the sticky inflation and persistent twin deficit concerns. Second, the key to growth revival lies in fiscal consolidation and easing of policy hurdles to infrastructure investments.
These had deeper connotation as the high-adrenaline bold push to reforms demonstrated by the government had increasingly fueled expectations of a rate cut among many market participants.
Against the backdrop of the macro report, it was, therefore, anticipated that though the RBI would refrain from cutting repo rate, it would continue with its liquidity supporting measures. As such, in line with our expectations, the Reserve Bank of India maintained a status quo on policy rate on Tuesday, and cut the cash reserve ratio by 25 bps to 4.25%.
By injecting an expected Rs 175 billion of primary liquidity into the banking system, the preemptive cut in CRR is expected to help curb the pressure on systemic liquidity from festive-related cash leakage and facilitate the flow of credit to the productive sectors in the economy, thereby supporting economic growth.
The bold steps undertaken by the government are expected to arrest the deceleration in growth momentum, curb the extent of fiscal slippage and help in sentiment revival, along with the much-needed stability in the exchange rate. However, it must be highlighted that, the full impact of these is likely to play out only in the medium term and the focus needs to be on early implementation, an observation underscored by RBI as well.
The RBI has outlined both upside and downside risks to inflation outlook. The monetary policy guidance, viz, a reasonable likelihood of further policy easing in Q4 2012-13, indicates that on balance, downside risks to inflation are expected to play out on the back of negative output gap, stable global commodity prices and, more importantly, appreciation bias to rupee. This would reflect in easing sequential momentum in core inflation. Once again, the RBI may shift its focus from headline inflation (unlikely to ease in the face of suppressed inflation becoming open) to core inflation in shaping its policy moves.
The second quarter review marks a clear shift in RBIs monetary policy stance towards addressing growth risks, whilst not de-emphasising the objective of containing inflation and anchoring inflation expectations.
In addition, the stance is likely to complement and, in some sense, amplify the positive spillover impact of recently announced government reforms on growth.
Many would wonder why growth has taken precedence over inflation in RBIs policy stance at this juncture. While supply-constraint driven inflation is unlikely to ease in the near term, there would be wider ramifications of rapidly declining growth with adverse spillover impact on financial stability and tax revenues. The shift in policy focus in this backdrop seems justified!
The writer is chief economist, Yes Bank