The Hindu Business Line : Optimism, caution and gradualism

Since central banking is as much about wordplay as interest rate fixing, it is time we instituted a mini Booker-type prize for the policy texts. For this category the wordsmiths on Mumbai's Mint Street would surely be strong contenders for a prize.

Their biannual policy statements are readable but not simplistic, nuanced but not Greenspanesque, and their plot get more and more interesting.

On the eve of this policy, too, there were many bitten nails, as two equally divided camps tried to predict the interest rate stance. With high and sustained credit growth, surely the price of credit needed to go up? The deficit data, both from fiscal and trade account, also indicated tightening. But look at the global slowdown, said the rival camp.

The US Federal Reserve Bank, too, has stopped raising interest rates, and oil prices are expected to soften. The housing slump in the US could have global repercussions. Ultimately, however, India's domestic factors outweighed, and the repo rate was hiked. There's an innovative twist to this hike too.

Becoming borrowers

Normally, the markets expect both the repo and reverse repo to move like synchronised swimmers. But this time the reverse repo rate, at 6 per cent, is unchanged. This is the rate at which banks have been parking their surplus overnight funds with the RBI. Going ahead, the policy signals that banks will probably move from lenders to borrowers at the overnight window. And here they will face a stiffer price.

Indeed, the repo borrowing will come close to resembling an auction, as it is supposed to be. The repo hike will surely raise short-term and deposit rates, but long-term funds are unlikely to become expensive.

In the policy review, the RBI admits being foxed by two unknowns. One, how to detect overheating. This is when demand far outpaces supply. And, two, what exactly is the output gap, or, in other words, what is India's potential GDP growth rate? If even the Planning Commission thinks 9 per cent is sustainable, then 8 per cent surely cannot lead to overheating.

Nuanced optimism

Some sectors, such as housing may, however, be susceptible. Housing and other asset price inflation is mixed up with foodgrains and commodities, which makes inflation-targeting messy.

And foodgrain inflation may not be cured by interest rate action alone — that requires a supply-side response.

Despite adopting a cautionary stance, the central bank has moved several steps further on opening up the capital account. The sector most vulnerable to completely opening up is banking, which is now divided into a leader and a follower class.

Banks with more global experience, including the foreign ones, will move go higher up the batting order as far as Basel-2 compliance is concerned. Others will follow a year later.

Thus a policy statement filled with nuance, optimism, caution and gradualism. A metaphor for the economy perhaps!

(The author is Chief Economist, Aditya Birla Group.)

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