There are two policy dilemmas before the monetary authorities. The traditional one is growth versus price stability. The closely related second one is the timing of the exit strategy.

Monetary policy reviews have ceased to be about interest rates alone but public interest continues to be focussed on likely interest rate changes. Thus a policy statement is often evaluated solely in terms of the direction it gives to interest rates.

For financial markets especially, other weighty issues discussed in the policy statements concerning the macro economy, financial sector reform and regulatory measures do not apparently matter as much as interest rate changes.

Such a view is short-sighted and obviously suffers from a fallacy. Interest rate changes, indeed the Reserve Bank of India’s monetary policy stances, are decided after due consideration of the economic scenario, both domestic and global. In that sense the interest rate stance is incidental to the main policy and cannot be the sole basis for evaluating it.

Policy rates unchanged

On October 27, in its second quarter review of the monetary policy, the RBI did not change the policy rates — the repo and reverse repo rates. These remain unchanged at 4.75 per cent and 3.25 per cent, respectively. Of the reserve ratios, the RBI did not alter the cash reserve ratio but restored the statutory liquidity ratio to 25 per cent from 24 per cent. At the height of the global financial crisis, the SLR was lowered by one percentage point to give banks additional liquidity.

With all policy rates and the CRR unchanged, the latest review ought to be considered benign or at least neutral on interest rates. Yet the consensus opinion is that even without signalling interest rate changes the central bank is edging towards a tighter monetary policy.

The hike in SLR is meant to increase banks’ investments in approved securities. In the process it hopes to curb liquidity. The SLR is calculated as a percentage of demand and time liabilities in the balance sheets of banks. The move however will have negligible impact: banks even now hold much more securities than statutorily required. Hence the RBI’s action cannot be construed as monetary tightening.

Two key issues

A view on the interest rate stance cannot be taken in isolation. Two important policy issues — one traditional and the other highly topical — have weighed with the RBI.

As always, there has been a policy dilemma in choosing a stance that either emphasises growth or price stability. Even a cursory reading of the review suggests that the RBI has come out in favour of price stability without, of course, taking measures that might impinge on growth. The RBI has found economic growth to be fragile.

It projects GDP growth at 6 per cent for 2009-10, lower than most other official forecasts. Although there has been a distinct recovery in industry, growth in services is below par. Agriculture is set to decline due to a poor southwest monsoon.

Inflation worries

Inflation is a bigger threat than it was three months ago. The RBI has projected WPI inflation at 6.5 per cent by March 31 with an upward bias, sharply higher than the 5 per cent it had forecast in July. Food inflation is a major concern. The RBI’s main challenge is to support the recovery process without stoking inflation.

This time, the traditional policy dilemma of growth versus inflation acquires a sharp edge in the context of the debate over the timing of an exit strategy.

Global in its scope — it affects almost all countries — the policy dilemma, simply stated, is at the heart of moves to withdraw from the accommodative monetary stance that was adopted in response to the global crisis. The RBI has since September 2008 drastically cut the repo rates and the CRR, pumping in liquidity and in general signalling lower interest rates. Has the time for a reversal come?

The key question: has the time come to withdraw the accommodative stance?

Making out a strong case for a debate that is both “quantitatively and qualitatively different from that in many other countries,” the RBI spells out the policy dilemma. Growth drivers warrant a continuation of the stimulus measures while inflation concerns call for an early exit.

Great significance is attached to a few regulatory moves that seem to suggest a gradual withdrawal of the accommodative stance.

For instance, banks will have to increase the provisioning requirement for advances to the commercial real estate sector, classified as standard assets, from 0.4 to 1 per cent. This would make loans to the sector more expensive.

However, it is too early to say whether the sector-specific measures are the first step towards a monetary stance that emphasises price stability above all other issues.