The Hindu : Monetary policy and macroeconomic goals

Online edition of India's National Newspaper
Thursday, May 01, 2003

Opinion

Opinion - Editorials

Monetary policy and macroeconomic goals

THE MONETARY AND credit policy for the year 2003-04, in line with all recent policy statements, is devoid of any spectacular announcements or policy changes. Looking at the way it has been evolving over the past few years, the monetary policy has come to be regarded as an authoritative review of macroeconomic and monetary developments coupled with an insight on the central bank's stance regarding certain critical areas of the economy. Whatever headline-grabbing news such as a bank rate cut there is, appears to be purely incidental. The RBI expects the GDP growth during 2003-04 to be 6 per cent, assuming a reasonable monsoon. For last year, the RBI's original forecast of GDP growth at 6 to 6.5 per cent was upbeat but had to be lowered during the year to a modest 4.4 per cent. While that is attributable to the decline in agricultural output, the overall performances of the industrial sector and services have been higher compared to the previous years. The RBI's projection of a higher macroeconomic growth during the current financial year brings into focus its monetary stance, which over the past few years has remained virtually unchanged. Provision of adequate liquidity to meet credit growth and support investment demand has been one basic tenet. The other has to do with the interest rate environment, with the RBI continuing to favour a softer and flexible interest rate regime. It is in amplifying its traditional stance that the recent monetary policy has to cover fresh ground to take care of the current economic variables.

A topical issue is the resurgence of inflation after having seen a steady and sustained decline. By the end of March 2003, the rate of inflation as measured by the Wholesale Price Index (WPI) on a point-to-point basis was at 6.2 per cent. It had remained below 4 per cent up to mid-January. The implication of this is obviously on the interest rate policy. A drastic fall in all types of market interest rates was possible only because of a benign inflation environment. The RBI expects the current pressures on the price front to ease shortly. Even before the cessation of the Iraq war, global oil prices have started coming down and there have been two reductions in the domestic oil prices since. The abundant food stocks helped in checking price increases in food items. However, the initial forecast of the South West Monsoon has not been positive. Manufacturing activities, now in a strong recovery mode, are likely to add to the pricing pressures: the prices of their products will be conditioned by the buoyant demand and remain sticky. It is therefore certain that the RBI will have to remain vigilant while tracking inflation. The advantages of a soft interest rate regime, aided by an abundant liquidity, are apparent. It has helped the Government in its borrowing programme and spurred credit offtake. Whether the same favourable factors will hold and soft interest continues in the foreseeable future however remains to be seen. Among other factors that will have a say are the growth prospects and investment demand besides the inflation outlook. Moreover, certain unanticipated domestic and external developments can upset policy calculations on the interest rate front as much as in the management of the external reserves, now at an unprecedented $72 billion plus. The RBI has been consistently non-doctrinaire in its approach to those two components of monetary policy.

The reductions in the bank rate from 6.25 per cent to 6 per cent and in the CRR from 4.75 to 4.50 have to be viewed in their proper perspective. Very likely the changes have been made either to signal a softer interest rate (through the bank rate) or meet a reform target (CRR cuts). On current economic variables alone, they are probably not justified. Interest rates might have bottomed out and there is abundant liquidity. The main message, however, is the need to be flexible in monetary matters. This year, with inflation likely to be a major concern, the RBI's oft-repeated advice needs to be re-emphasised.

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