Entirely in line with market expectations, the Reserve Bank of India in its second quarter review of monetary policy has hiked the policy repo rate by 0.25 percentage points to 7.75 per cent and reduced the marginal standing facility (MSF) rate by an identical margin to 8.75 per cent. While the cash reserve ratio (CRR) has been left unchanged, the Bank has addressed liquidity concerns by doubling the quantum of funds through term repos of 7 days and 14 days tenor. This facility has been introduced very recently and has been seen as a big step forward in the evolution of the short-term money market. The difference between the repo rate and MSF rate has been brought down to one percentage point and this marks the attainment of one of the important stages in the normalisation of monetary policy. As part of the extraordinary measures introduced in July to arrest the rupee’s decline the MSF was hiked and made the reference point for short-term interest rates. With the rupee now stabilising, the RBI has thought it fit to revert to its traditional monetary policy stance of targeting inflation without compromising on genuine credit needs of industry, relying primarily on the short-term policy rate. The hike in the repo rate indicates the Bank’s concerns over the persistently high inflation as reflected in both the WPI and CPI. Inflation expectations remain high partly due to the ongoing adjustment in fuel prices. Quite significantly, retail inflation is expected to remain “around or even over 9 per cent” having risen sharply across food and non-food items including services. This could indicate further rate hikes in the near future.

The central bank had downgraded its growth projection for 2013-14 to 5 per cent from 5.5 per cent. Even this is higher than practically all other forecasts, by both private and multilateral agencies including the IMF. Economic growth during the first quarter (April-June) has been just 4.4 per cent. Both the government and the RBI hope that the second half of the year will be much better on the back of good monsoons. The external economy which has been under stress has received some good news more recently. Exports have improved over the last two months — to a large extent reaping the benefits of rupee depreciation — and along with a contraction in non-oil import demand helped in narrowing the merchandise trade deficit. This has very favourable implications for the current account deficit which is expected to be much lower than feared until recently. Among the important non-monetary measures announced, the proposal to introduce retail inflation indexed securities is a welcome development. If properly designed, it should help in mobilising household savings for productive investment.

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