On the eve of the Reserve Bank of India’s quarterly review of monetary policy, there was hardly any doubt that its concerns would remain focused on inflation. On Monday, a day before the review, the central bank reiterated the point that inflation remains sticky, with strong upside risks even at a time of sharp deceleration in the economy. More than at any time in the recent past, expectations from the financial markets for a rate cut were muted. Therefore, the decision to hold on to the policy rates and the cash reserve ratio while lowering the statutory liquidity ratio by one percentage point to 23 per cent was entirely on expected lines. The SLR reduction will augment liquidity and enable a more orderly monetary transmission. By far a bigger message is conveyed by the inaction on interest rates. The quintessential growth versus inflation debate has for the time being been settled in favour of price stability, without of course ignoring growth concerns. The RBI has more than once pointed out that inflation is inimical to growth; that low and stable inflation is an essential pre-condition for securing medium term growth; while monetary tightening has resulted in some sacrifice of growth in the short-term, in the medium-term, there is no trade off between growth and inflation control.

Slowdown concerns were very much in the RBI’s view when it frontloaded the policy rate reduction in April with a 50 basis points cut. However, since then, adverse developments impacting on both growth and inflation at home and abroad have made the RBI pause. Investors and policymakers alike closely watch the central bank’s projections of growth and inflation. The growth forecast for 2012-13 has been revised downwards from 7.3 per cent to 6.5 while the baseline projection for WPI inflation for March 2013 has been hiked to 7 per cent from 6.5. But there may be more gloom around the corner. External risks to the outlook for the Indian economy are intensifying. The festering euro area’s problems have increased risk aversion, financial market volatility and perverse capital flows. Weather related adversities in several parts of the world and the uncertain outlook for food and commodity prices, especially petroleum, have adverse implications for domestic growth and inflation. The deficient monsoon will exacerbate the already high food inflation. Failure to narrow the twin deficits — fiscal and current account — with appropriate policy actions threatens both macroeconomic and growth stability. Through its actions, the RBI hopes to anchor inflation expectations while maintaining enough liquidity to facilitate the smooth flow of credit to productive sectors.

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