For monetary policy watchers, the Reserve Bank of India’s decision to keep policy rates and the cash reserve ratio (CRR) unaltered ought to be a source of comfort. Few had expected the RBI to hike the repo rate; fewer still had hoped for a reduction. In matching the expectations of the overwhelmingly large majority, the RBI is sending out a message: that notwithstanding the recent nasty surprises it sprang on the markets, the broad contours of its policies can be anticipated even over the short-term. That, in turn, should enhance the credibility of its guidance, especially on continuing with the strong liquidity-squeezing medicine it administered over the past few weeks to check volatility in the exchange markets. Those measures did succeed initially. But they cannot be rolled back just yet. As the RBI puts it pithily but inelegantly, India is currently caught in a classic “impossible trinity trilemma” and has to forfeit some monetary policy discretion to support the external sector. Only when it is satisfied that stability has been restored in the foreign exchange markets will the bank consider a calibrated retreat. While not being in a hurry to loosen its policy, the RBI has given an assurance that with the right conditions prevailing, monetary policy will revert to supporting growth while maintaining a vigil on inflation. That, unfortunately, seems far away as the rupee quite unexpectedly tanked again on Tuesday. The authorities have been quick to blame speculation but only the next weeks will show whether it is a one-off development or the beginning of a new period of stress for the rupee.

The RBI sees a window of opportunity in its recent measures, which should be used to address structural issues on a war footing so that the burgeoning current account deficit can be checked. The CAD appears to have climbed up again in the first quarter of the current year. Other risk factors include a weak investment climate with high risk aversion. The industrial outlook is inhibited by time and cost overruns, and deteriorating asset quality, among other factors. Low and stable inflation will anchor inflation expectations and is absolutely necessary to sustain growth over the medium term. The RBI has revised its projection for growth during 2013-14 from 5.7 per cent in May to 5.5 per cent. The new estimate might be conservative. A revival in the latter part of the year, albeit at a slow pace, is widely expected on the back of good monsoons. Most professional forecasters are looking at a slightly higher GDP growth rate. But this can only happen if the RBI contains headline WPI inflation to around 5 per cent in the short-term and to 3 per cent over the medium term.

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