Given that inflation continues to be the main worry for policymakers, it is not surprising that the Reserve Bank of India, in its second quarter review of monetary policy, has extended its policy of monetary tightening, raising the repo rate by another 0.25 percentage point to 8.50 per cent. Although manufacturing and core inflation have moderated sequentially, year-on-year inflation continues to rule well above the RBI's medium-term targets. Arguing that any premature withdrawal from what has been a consistent policy stance since February 2010 will entail the risk of leaving inflation expectations unhinged, the RBI has, for now, ignored the growing clamour for a “pause” in hiking interest rates. It has, however, conceded that some important growth indicators are slowing down at a rate faster rate than anticipated, partly due to the delayed impact of previous interest rate hikes. Slower growth in the United States and the spiralling sovereign debt problems in Europe pose significant challenges for the management of external economy. Petroleum prices remain sticky and the sharp depreciation in the rupee can offset the gains from the fall in other commodity prices. However, the good news is that, in RBI's assessment, inflation is likely to moderate from December onwards. In its clearest message yet of a softer monetary policy ahead, the RBI says that the possibility of a rate hike in the December policy review “is relatively low”. While retaining its inflation target for March 31, 2012 at 7 per cent, the RBI says that monetary policy will have more room for addressing short-term growth concerns.

The RBI's growth estimates have generally been more conservative than those of the government. In May, the annual policy statement had projected an 8 per cent growth for 2011-12, at least 0.50 percentage point higher than what most official estimates indicated. In the light of growth trends during the first half of the year, the RBI has revised it to 7.6 per cent. Among the development and regulatory policies announced along with the review, the deregulation of savings bank interest rate stands out. With this, administered interest rates will be confined to a very narrow spectrum of small savings schemes. Ironically it was only recently the government decided to borrow Rs.50,000 crore more than was budgeted to offset a huge fall in small savings collections, which were drifting towards bank deposits. In a deregulated environment there will be stiffer competition and that should be good for savings bank account-holders. But the biggest impact will be on the banks themselves. The way the leading ones manage their balance sheets will be keenly watched.

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