The monetary measures announced by the Reserve Bank of India in its third quarter review of monetary policy are entirely in line with market expectations. The policy repo rate and the Cash Reserve Ratio (CRR) have each been reduced by 0.25 percentage points to 7.75 per cent and 4 per cent respectively. The latter will inject approximately Rs.18,000 crore into the banking system and thus provide some succour to a market reeling under a liquidity shortage. The central bank, in its previous policy statements, had more or less committed itself to an interest rate reduction at the start of 2013, which incidentally is the first since the unexpectedly large 0.50 percentage points cut in April. However, neither the latest policy measures, nor the guidance in the review, give a clue as to whether a softer interest rate policy characterised by many more — possibly — larger reductions in the repo rate is in the offing. As before, the RBI is hedging its bets: on the expectation of inflation remaining range bound at current levels, there is space, albeit limited, for monetary policy to place greater emphasis on growth, it says.

The RBI’s reluctance to come out with a clearer projection of monetary policy is understandable and is best understood in the light of the two significant macroeconomic trends relating to growth and inflation. The RBI has revised its baseline projection of GDP growth for the current year to 5.5 per cent from 5.8 in October, bringing it in line with official statistics. Headline inflation measured by the WPI index has been moderating recently. A sustained reduction in inflation pressure is contingent upon alleviation of supply constraints and progress on fiscal consolidation. However, taking into account the several positive developments on the inflation front, notably the sustained fall in core inflation, the RBI has revised the inflation projection for March 2013 to 6.8 per cent from 7.5 per cent, set out in the second quarter policy review. Among the several risk factors impinging on macroeconomic management, the widening of the current account deficit to historically high levels in the context of a large fiscal deficit and slowing growth exposes the economy to the dangers of the twin deficits. Global risks remain elevated. A sustained revival in investment is absolutely necessary for stimulating growth and depends on a number of factors such as bridging the infrastructure gaps and better governance. Monetary policy’s traditional dilemma of supporting growth versus countering inflation can perhaps never be fully reconciled but the compact and lucid third quarter review has done a very good job of articulating an inherently complex stance.

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