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Holding The Line, Tightly

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Simply put, there were no surprises in the Reserve Bank of India's (RBI) mid-quarter review of monetary policy on 16 December. No rate hikes, no CRR (cash reserve ratio) cuts, no policy measures of any kind. There were no expectations of anything dramatic, of course: most analysts were sure there would be no rate hike.

Readers will recall that in the second quarter review in late October this year, RBI governor Duvvuri Subbarao had said that if things remained the same, there would be a pause in the policy interest rate hiking cycle. He was as good as his word. In its statement on this mid-quarter review, the RBI says that if the current downward trend in inflation continues, "monetary policy actions are likely to reverse the cycle, responding to the risks to growth". Music to the sensitive (though occasionally tone deaf) ears of Indian industry.

But some did hope for a cut in reserve requirements, specifically the CRR, to add liquidity in a relatively tight market. "Why should there be one, when the banks aren't using the marginal standing facility (MSF)?" asks Indranil Pan, chief economist at Kotak Mahindra Bank. "The liquidity is just where it should be under current conditions."

Liquidity is tight, most market analysts will tell you; but as Devendra Kumat Pant, director at Fitch Ratings, points out, liquidity conditions are always tight at this time of year (it used be called the ‘busy season', when credit growth was usually higher than in the first half of the financial year).

This time round, the tone of the announcement, which has been rather ‘hawkish' until recently, is cautious. In its outlook for the rest of the financial year and beyond, the central bank has underscored the risks to growth; it also points out that sudden events could arrest the downward momentum of inflation. Of course, it could be that the RBI is covering all bases.

Does this mean the RBI will review what it can do to push growth? Not really. First, the RBI is unable to do anything about global events, other than try and prepare the best possible defence. As the announcement said clearly, the risks to growth are on the ‘downside', meaning lower pace of growth is highly probable.

Second, events in the domestic arena have been dominated by the failure of the government to contain spending with budgeted limits, which adds to inflationary pressures and inflation itself. The RBI cannot do anything about public finances either. As it is, the central bank is left fighting inflation with one hand tied behind its back. It is hard to focus on growth with limited maneuverability.

Under the circumstances, perhaps doing nothing was the best thing to do; sometimes, that is the hardest thing to do.

(This story was published in Businessworld Issue Dated 26-12-2011)