The Reserve Bank of India has brought down the Cash Reserve Ratio (CRR) by 0.25 percentage points but left the policy repo rates unchanged. The reduction in the reserve ratio will release Rs.17, 000 crore into the banking system immediately. The expectation is that this extra liquidity will induce banks to reduce interest rates, an outcome keenly sought by sections of industry. The central bank’s approach is tactically sound: a more direct interest rate signal through a repo rate cut would be against the grain of recent monetary policy actions which have accorded primacy to curbing inflation, without entirely ignoring growth concerns. Headline WPI inflation has remained sticky at around 7.5 per cent throughout the financial year. For August it was at 7.55, up from a 32-month low of 6.87 per cent in July. Core inflation pressures remained firm with non-food manufactured products inflation inching up from 5.1 per cent in April to 5.6 per cent in August. In every category, the easing of price pressures on a few items has been offset by a rise in others. Fuel inflation in August has picked up on the back of an upward revision in electricity prices. The recent hike in diesel prices and rationalisation of LPG subsidy will add to overall price pressures.

Inflationary pressures are likely to be underpinned by the recent actions of the European Central Bank and the U.S. Federal Reserve, which will have the overall effect of boosting global liquidity. That in turn will drive up global commodity prices. For India, imported inflation will remain a threat over the near term. All these suggest that there is no way to shift the monetary policy focus away from countering inflation and anchoring inflation expectations. However, even though domestic growth remains sluggish, the recent reform measures announced by the government have, according to the RBI, started reversing sentiments. Reducing fuel subsidies and selling stakes in public sector companies will lead to some fiscal consolidation. But these, like the moves to stimulate foreign direct investment, will take time before their potential benefits are realised. Without in any way discounting monetary policy’s role in supporting the growth revival, the RBI is categorical in stating that continuing inflationary pressures alongside risks emerging from the current account deficit and fiscal deficit constrain a stronger policy response to growth risks. Restricting monetary action to a CRR cut for now is a good idea. It gives the central bank time and space to reorient policy in response to the evolving growth-inflation dynamics.

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