A policy of caution

A cautious wait and watc
20 May 2004

What with a budget yet to be presented, a government yet to to be sworn in, stock markets in turmoil and an uncertain oil price scenario, the Reserve Bank of India's (RBI) monetary policy for the year 2004-2005 has no option but to adapt a wait and watch policy.

The growth in the gross domestic product (GDP) is expected to be between 6.5 to 7 per cent and inflation to be contained at 5 per cent. YV Reddy, governor, RBI however, has qualified that since industry is picking up momentum and as the rains are expected to be plentiful and well distributed, GDP growth could surpass the 7 per cent mark. Likewise, given the uncertain oil price scenario, inflation could rise above 5 per cent.

There has been no change in the bank rate, the repo rate and the cash reserve ratio. The RBI governor did not mention the uncertain political scenario and the country's future direction on reforms as he is not expected to mention it. These thoughts, however, must have weighed on his mind, which led him to adopt a policy stance of caution with a watchful eye so that the RBI is prepared for any eventuality. On interest rates, Reddy said that the central bank would maintain `status quo' as there are some signs of economic recovery and interest rates in major economies are likely to harden. "In the view of widespread anticipation that international interest rates may rise, there may be a case for raising interest rates, however, such an increase may have an adverse impact on the investment demand, which has shown signs of a pick up after prolonged sluggishness," he said.

On the other hand, Reddy has pointed out that while a case can also be made for lowering interest rates to foster investment activity domestically in the context of capital flows, an assessment of domestic factors relevant to India points to stability, but in the leading economies of the world, there is a greater potential for tightening rather easing of monetary policies.

Addressing concerns on the inflation front, the governor said that it expects the inflation rate in 2004-05 to be at around 5 per cent, on a point-to-point basis, assuming there are no significant supply shocks and there is appropriate management of liquidity. The overall stance of the monetary policy 2004-05 will be to provide adequate liquidity to meet credit growth, support investment and export demand in the economy, while keeping a close watch on inflation.