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Monetary Policy: Readying for Growth?

LiveMint logoLiveMint 03-06-2014 Renu Kohli

As widely expected, the Reserve Bank of India (RBI) kept its policy, or repo rate unchanged at 8%. Reiterating its consumer price index inflation target of 8% by January 2015, the central bank struck greater confidence on the growth front than it did two months ago. Although it retained its forecast of 5-6% real gross domestic product (GDP) growth in 2014-15, the RBI adjusted the risks to its central estimate of 5.5% from ‘downside’ in April’s to ‘evenly balanced’ now. The central bank’s growth fan chart shows that there is now a 50% chance that growth will be in a 5.25%-6.25% range – thanks to easing of domestic supply bottlenecks, implementation of stalled projects and resumption of export growth. Two months ago it expressed similar confidence albeit for a lower 5.1%-6.1% range. It sees the ‘decisive election result’ plus improved sentiment creating “a conducive environment for comprehensive policy actions’, ‘revival in aggregate demand’ and a ‘gradual recovery of growth’ during the year.

A suitable backdrop then for reapportioning a bit of domestic savings from government to private sector, whose demand is anticipated to increase in line with this expected pick-up in economic activity. Hence the RBI’s deregulation, viz. a reduction in statutory liquidity ratio (SLR) — the minimum level of government securities banks must compulsorily hold -from 23% to 22.5% of net demand and time liabilities, is well timed. The effects will play out over time in the financial system though, as banks’ current investments (29.3% on May 16) are trending way above threshold level. From the standpoint of institutional changes, the SLR reduction signals that fiscal policy is starting to realign in accordance with the revised monetary policy framework recommended by the Urjit Patel Committee. Demand for government borrowings will now be a little less assured with this move.

Inflation risks are balanced, relative to April readings, with the ‘possibility of stronger Government action on food supply’ and ‘better fiscal consolidation’ as well as exchange rate appreciation effects. Note the contribution of a 2% appreciation in May in keeping disinflation on its predicted path. What if exchange rate movements had been otherwise or even stable? That makes one think of exchange rate-consumer prices movements ahead. If capital inflows sustain, could a stronger currency nudge disinflation a tad faster than expected? The RBI’s guidance states that a faster-than-currently-anticipated pace of disinflation, adjusted for base effects, will provide the headroom for an easing of the policy stance in future. Hard to say at this point as to what role a stronger currency might play in stabilizing prices ahead.

A related question in this regard: What of the growth-inflation tradeoffs vis-à-vis exchange rate movements? How much growth could be impacted via reduced exports? That’s why the balance of outcomes on inflation and growth is worth watching out for.

Renu Kohli is a New Delhi-based macroeconomist.

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