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The RBI's shifting focus

Mohan Shenoi

THE RBI's Monetary Policy stance has changed from the Mid-Term Review of October 2004. In the latest review, price stability had emerged as the crucial determinant of its monetary policy stance.

The conduct of monetary management in 2004-05 second half was broadly on these lines. The latest Monetary Policy statement highlights similar risks going forward.

It had indicated in its October 2004 Policy that it considers important to recognise the risks of stronger adjustments that may be needed if less than adequate adjustments are made at the appropriate time.

This logic appears to have, once again, formed the basis for the hike in the reverse repo rate by 25 bps to 5 per cent. The current liquidity overhang, indicated by trends of reverse repo acceptance by the RBI, also remains substantial.

This also probably guided the RBI to hike its reverse repo rate to suck out the liquidity from the system.

Consequent to the 25 bps hike in the reverse repo rate, the 10-year benchmark G-sec yield has moved to around 7.22 per cent compared to the pre-Policy level of 7.12 per cent.

However, irrespective of the reverse repo rate hike, bond yields were expected to inch up, in view of the large government borrowings concentrated in first half of 2005-06.

The 10-year benchmark yield can be expected to inch up to around 7.50 per cent and beyond with successive government securities auctions.

The hike in the reverse repo rate is expected to affect the shorter end of the yield curve as well. The call/notice money and treasury bills rates are expected to inch up by 15-25 bps.

The dollar-rupee rate is unlikely to be impacted by the Credit Policy. Here, the continuing volatility of international crude oil prices and India's widening current account deficit will play a key role.

The RBI is unlikely to allow FII flows to unleash appreciation pressures in view of the current account deficits. The dollar-rupee rate is expected to remain in the 43.50-44 range for most part of this year.

(The author is Treasurer, Kotak Mahindra Bank.)

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