The measures implemented in the latest monetary policy seem to indicate a shift in the line of thinking of the RBI. There is no doubt that inflation control is the biggest worry of the governor. Yet, while earlier instances of the same have resulted in a slew of interest rate hikes along with changes in reserve requirements, this time, it has chosen to restrict inflation controlling measures to only an increase in CRR by 25 bps.
There are quite a few reasons that collectively might explain such a response. Firstly, this 25bps increase in CRR would be the third 25 bps increase that would be actuated in a period of 1 month. Hence, if we consider the changes made over the last few weeks along with the changes implemented in the policy, a more hawkish picture emerges on inflation.
Secondly, there have been significant fiscal measures taken by the government to control inflation. This time, it is a combination of fiscal and monetary measures. Such a scenario allows the RBI to maintain interest rates unchanged at high inflation. If these measures are effective, it could be a shot in the arm of the case for coordinated effort and measures. Finally, its possible that the RBI has recognized the low effectiveness of the repo rate mechanism for inflation control. Without an effective transmission mechanism in place, viz, the bond-currency-derivative (BCD) markets, the impact of interest rate hikes on inflation control would be minimal. In order that a rate hike be effective the RBI would need to increase rates significantly ? which is bound to further impact growth. Two other aspects come out strongly from the recent announcements. Firstly, the effective change in CRR over a period of a month would be 75bps. How the banking companies decide to deal with the Rs.3,000 Cr loss in NIMs needs to be seen. Its most likely that banks would increase their risk premiums, while maintaining their PLRs constant. Thus, lower graded borrowers would be affected and hopefully the impact on growth would be contained within that segment of the economy.
Secondly, having recognized the lack of a ?BCD nexus? as an effective transmission mechanism for monetary policy, the RBI has begun efforts to build strong bond and currency markets. On the currency markets, the policy document sets up a timeframe under which the RBI and SEBI would come up with the regulatory framework. On the bond markets, the policy has a lot of positive statements to improve liquidity by introduction of STRIPS, changes in the NDS, floating rate bonds and more.To sum it up, this year?s policy seems to have many aspects that could have a positive impact on the monetary policies in the future. The regulator and the government have acted in constructed harmony. Secondly, there appears to be some recognition for stronger bond and currency markets with specific steps to achieve the same.
The author is a national leader, financial services, Ernst & Young. Views expressed in the article are personal