- Developments since then have obviously not warranted a change. Neither the short-term policy rate (the repo rate and the reverse repo rate) nor the Cash Reserve Ratio has been changed this time .But the central bank has announced far reaching changes in domestic liquidity management.
- The Statutory Liquidity Ratio (SLR), the proportion of deposits that banks have to compulsorily invest in government securities, has been brought down from 25 per cent to 24 per cent.
- Second, the RBI will also conduct open market operations (OMO) for purchase of government securities for an aggregate amount of Rs.48,000 crore.
- These two measures will release liquidity on an enduring basis to the extent of Rs.48,000 crore. These replace the ad hoc measures that were put in place to provide succour to a market that was facing liquidity shortages.
Liquidity infusion
Does the liquidity infusion indicate a change in the anti-inflation stance? The RBI has explained that an expanding economy needs primary liquidity which "will have to be provided in a manner consistent with the monetary stance.'' At the present juncture, shortage of liquidity is becoming a serious issue hampering banks' efforts to provide credit to the fast growing economy. It is, therefore, a case of the central bank straddling two different objectives.
Besides, it is not clear how the liquidity infusion will affect interest rates. Banks have started offering higher interest rates on their deposits, whose growth has been sluggish this year. At the same time credit has been expanding. Higher interest rates were probably on the cards anyway. Inflation expectations are likely to be reinforced in the wake of rising petrol and possibly diesel prices. The RBI may have to signal higher interest rates to anchor inflation expectations.
Concern over inflation
In any case, inflation remains a major concern. The RBI feels that there is 'an upside risk' to its inflation projection of 5.5 per cent for March, 2011, suggesting that its earlier estimate may be exceeded.
The warning has come despite a recent drop in both Wholesale Price Index-based and certain types of Consumer Price Index-based inflation. After remaining in double digit for five successive months, headline WPI-based inflation declined to 8.8 per cent in August and further to 7.5 per cent in November. CPI-based inflation for industrial workers and rural/agricultural labourers declined to single digit from August after remaining in double-digit for over a year. Yet, these welcome trends mask the fact that there have been structural changes in the politically sensitive food inflation. At one level food inflation has moderated following a good monsoon. From an average of 15.1 per cent in the first quarter of this year, it came down to 10 per cent in October and further to 6.1 per cent in November. However, the moderation in inflation for cereals and pulses has been larger than that in inflation of protein related food items such as eggs, fish, milk and meat.
As personal incomes expand, the consumption of the latter category items will increase.
Hence, the pace of moderation in food items has been slower than expected. Besides, inflation for non-food primary articles such as raw cotton, raw rubber and minerals rose sharply.
Growth forecast
Despite the recent moderation, inflationary pressures persist both from domestic demand and higher food prices.
The sharp rise in international commodity prices is another big threat. As seen in the case of petroleum products, high global commodity prices are spilling over into the domestic economy.
Perhaps the only surprise in the mid-quarter review is the RBI sticking to its growth projection of 8.5 per cent for 2010-11.
According to official statistics, the economy has grown by 8.9 per cent in each of the first two quarters. Most official and non-official forecasters have already started marking up their estimates to 9 per cent. The RBI will most probably revise its projection in the third quarter review scheduled for January 25, 2011.
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