labels: rbi, economy - general
Credit policy driven by concern for price stability news
24 April 2007

The Reserve Bank of India did not surprise the markets as it left all key rates unchanged and maintained a status quo on its monetary policy stance. However, the RBI lowered its growth forecast to 8.5 per cent from 8.5-9 per cent as it expects global GDP to decline in 2007.

It is important to note that the monetary policy stance is exactly what it was in the Jan 30 policy meet. The stance of the policy in 2007-08 will be conditioned by the patterns in which the global and the domestic environment unfold.

The basic objective of monetary policy is price stability and adequate credit flow to the productive sectors of the economy. Managing the capital flows has emerged as an important concern of monetary policy. The phasing out of ad hoc treasury bills and their automatic monetisation in 1997 imparted a lot of flexibility to RBI in monetary management.

Inflation remain key focus area
Inflation fighting seems to have been the predominant stance this time as inflation targets were revised downward to 5 per cent from last year's targets of 5-5.5 per cent. RBI's medium term inflationary target is now 4-4.5 per cent. Reacting to the announcement, Finance Minister P Chidambaram said that it is RBI policy to curb inflation without hurting growth and the Government has no view on rupee exchange rate.

According to the report, a significant worrisome feature of domestic developments in 2006-07 was the firming up of inflation, which represents the key downside risk to the evolving macroeconomic outlook. The recent hardening of international crude prices has heightened the uncertainty surrounding the inflation outlook.

A careful assessment of the manner in which inflation is evolving in India reveals that primary food articles have contributed significantly to inflation during 2006-07. At the same time, prices of manufactured products account for well above 50 per cent of headline inflation.

Progress on CAC:
The apex bank has also announced important operational tools for moving towards capital account convertibility(CAC). This means Indian companies can now invest in foreign companies upto 300 per cent of their net worth, hedge remittances upto 100,000 dollars as against 50,000 dollars earlier, etc. Simply put, this means individuals who could spend USD 50,000 abroad for capital and current account transactions can now spend USD 100,000.

Markets and analysts reaction
The market has welcomed the move though Anish Damania, Head of Institution Sales, Emkay feels that "There are some hawkish statements which one has read more into". A Balasubramium of Birla Sun life MF has termed the RBI move as positive for market as well as banking system. Inflation target for medium term has been reduced to 4-4.5 per cent, which augurs well for markets.

What's ahead
The policy preference for the period ahead is strongly in favour of reinforcing the emphasis on price stability and anchoring inflationary expectations. It means that the RBI continues to maintain its caution on inflation and continues to maintain that price stability is more important than growth.

Ajay Shah, Economist with IGIDR, doesn't think that this stance of monetary policy will slowdown inflation. There is usually, a long lag between real rates slowing down the business cycle. He thinks, at this point, the real rates will not slow down the business cycle. The story is far from over, and there may be problems in store on inflation, he feels.

also see : Annual Credit Policy: RBI keeps all rates intact

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Credit policy driven by concern for price stability