The Reserve Bank of India’s mid-year review of the credit policy, the first policy statement of Governor Subba Rao, has been presented under certain extraordinary circumstances. The global financial system is in a deep and unprecedented crisis. Central banks and governments the world over are facing several complex and compelling challenges. There have been severe disruptions in money markets. Stock markets across the world have been in a free fall and there has been extreme risk-aversion in all financial markets. Policy makers across the globe are responding with aggressive, radical and unconventional measures to restore confidence and impart stability to the system. Domestic financial markets have been affected in an indirect way. There has been a tightening of liquidity and the rupee has come under renewed pressure but most significantly, the stock markets have lost half their value since January. For more than a month now, the government and the RBI have sought to address the multiple concerns in a number of ways, conventional and non-conventional. The measures include a reduction in the CRR by a cumulative 2.50 percentage points and a one percentage point reduction in the repo rate.

The flurry of announcements and steps that were taken ahead of the policy probably made any new measure redundant. Keeping all the key monetary rates unchanged in the mid-year review might have been a technically sound response but the RBI failed to read the market expectations and psychology correctly. The disappointed stock markets plunged to record lows on Friday. The RBI has since given out a strong message that it will intervene with both conventional and non-conventional means depending on the evolving circumstances. More importantly, even in this difficult environment, monetary policy has to strike a judicious balance among price stability, sustaining the growth momentum, and maintaining financial stability. The ongoing global financial turmoil requires that a greater emphasis is placed on financial stability but concerns arising out of a slowing economy and the double-digit inflation cannot be wished away. The RBI has lowered its growth forecast for the current year to between 7.5 and 8 per cent and stuck to its earlier projection of inflation at 7 per cent by the end of March 2009. The adverse consequences of the global slowdown flowing principally through trade and financial channels but also through weakening sentiment will hamper domestic growth. Global commodity prices have come down but are still at elevated levels. Very significantly, non-food credit has been growing well beyond the RBI’s target. Taking all these signals, at times contradictory, into account, the RBI has to walk a very fine line.