labels: finance - general, economy - general, governance
Fine balance between growth and stabilitynews
The RBI has done well to move in tandem wi
05 May 2005

Ajay MahajanThe Reserve Bank of India has made the right move by balancing growth with price stability, rather than pursuing only growth at the risk of inflation getting out of control. The central bank has very aptly recognised both the supply side and demand pull pressures working the inflation up and has consequently chosen to move early and raise the reverse repo rate by a quarter of a percentage point to five per cent.

The bond markets did not expect a rate hike, perhaps in the wake of softer global data pointing towards a pause in the global interest rate tightening cycle and also because headline inflation numbers looked benign. However, the devil is often in the details - one such detail being that oil price hikes have not yet been passed on to the domestic consumer.

Moreover, at the current level, inflation might appear muted and is likely to get a cushion from the high base of last year. Another caveat worth noting is that the core wholesale price inflation (excluding the volatile food and energy components) is starting to creep up again and the latest figures reveal that this core reading is currently at 5.18 per cent - the highest since December of 2004. Aside from that, inflation is not only supply-driven but as our output gap suggests, demand-pull inflationary pressures are also starting to build up in the economy.

With regard to the international economy, there is no denying the fact that global pressures are intensifying. The US Federal Reserve has raised interest rates eight times in the past 10 months and the Fed fund futures see the Fed target rate close to 4 per cent by the end of this year. While Alan Greenspan has reiterated that monetary accommodation will continue to be removed at a 'measured' pace, the Fed seems to be taking greater cognisance of inflationary risk building up in the US economy. This is evident from the omission of the previous reference to the lack of increase of energy prices reflecting in core inflation. With worldwide interest rate pressures building up, the RBI has done well to move in tandem with the global economy. On balance, we believe that the policy statements seem to be in line with the current macro-economic dynamics.

In the interim, we believe that the elimination of uncertainty would provide stability to the bond markets. Having said that, the interest rate environment remains adverse and opportunities from the "buy" side are likely to remain short-lived in a market that has to deal with the government's large debt supply, apart from the liquidity demands being driven by the industry.

Overall, the policy is forward looking from the perspective of developing the foreign exchange, fixed income and derivatives businesses. While T+1 settlements will help balance sheet managers in more effective liquidity management, freeing cancellations of contracts would provide more flexibility to the corporate treasurer in managing his currency risks better.

Besides, there is talk of providing 'primary dealers' exclusivity in relation to government bond auctions, which would give them the much desired competitive edge. There is also a proposal to consider permitting corporate customers to write "covered calls" which is likely to aid clients in improving their hedge economics. The decision to consider "limited short selling" is a welcome, although a long-awaited step.

The proposal of consolidation of debt securities, aimed at building up liquidity, is also a positive move. Another remarkable initiative taken by the Reserve Bank of India is that of 'communicating with the market' more often on the monetary policy stance as part of global best practices — quarterly reviews of the credit policy would ensure a more structured interaction with the markets, thereby enabling a more efficient response in the fast changing global monetary dynamics.

Lastly, we see marginal impact on borrowing and lending rates of major banks as the longer term interest rate benchmark is still steady at six per cent and bulk of the banking system is not borrowing from the central bank. Largely, it should be status quo for banks and businesses, going forward.

*The author is president, financial markets, Yes Bank

 


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Fine balance between growth and stability