Leaving all key policy rates unchanged, the RBI’s mid-quarterly policy review makes it clear that while growth is strong, inflation continues to remains a key concern, despite some moderation in food price inflation. This is because of domestic demand pressures, the edging up of non-food manufactured products inflation to 5.4 per cent in November, and the surge in international commodity prices – oil, food, metals and other industrial inputs.

RBI has not changed its current monetary policy stance (tightening) though for the present, it has left unchanged the repo, reverse repo and CRR at 6.25, 5.25 and 6 per cent respectively. The GDP growth projection for current fiscal is also retained at 8.5 per cent but inflation is still “above comfort level” and there is a risk on upside to its earlier projection of 5.5 per cent by end of March 2011.

Meanwhile, liquidity tightness has posed a challenge for the central bank and this is attributed to the persistence of large Government cash balances and sluggish growth in bank deposits at a time of credit expansion on a sustained basis. The current focus is therefore to alleviate the liquidity pressures. The permanent reduction of SLR by one percentage point will provide additional cushion to the banking system to enable it to meet the productive needs of the economy.

RBI will address the monetary and other developments in its third quarter review (2010-11) on January 25, 2011. The current review underlines the slow recovery in the global economy and, in particular, financial stability concerns from the recurring sovereign debt problems of countries in the Euro-zone. While the growth momentum in emerging economies is strong, reflecting the strength of demand and higher commodity prices, inflation has been creeping up in these economies as well.

To sum up, the RBI review says, the underlying growth momentum of the Indian economy remains strong but inflation though moderating, significantly above the comfort level of the Reserve Bank. Moreover, risks to inflation remain on the upside, both from rising input costs for the manufacturing sector combined with aggregate demand pressures. And rising international commodity prices could spill over into domestic inflation.

There is, therefore, need for continued vigilance on the inflation front against the build-up of demand side pressures. Meanwhile, RBI is addressing the challenge of liquidity management with measures to alleviate the liquidity pressure “in a manner consistent with the monetary policy stance of containing inflation and anchoring inflationary expectations”

On liquidity, the review said the extent of tightness has been beyond the comfort level and the liquidity deficit has been accentuated by structural factors such as significantly above-trend currency expansion and relatively sluggish growth in bank deposits even as the credit growth accelerated in 2010-11. While the liquidity deficit improved transmission of monetary policy signals with several banks raising deposit and lending interest rates, excessive deficits induce unpredictability in both availability and cost of funds, making it difficult for the banking system to sustain credit delivery.

RBI has been providing additional liquidity support to banks through its open market operations. It would conduct OMO for purchase of government securities for an aggregate amount of Rs. 48,000 crore over the next one month. The OMO amounts are indicative and the Reserve Bank will have the flexibility in the scheme including the frequency, timing and the amount of OMO as may be necessary depending on the evolving liquidity and market conditions, the review said. Such provision of liquidity should not be construed as a change in the monetary policy stance since inflation continues to remain a major concern.

Thus, the policy actions announced on December 16 are expected to release sizeable primary liquidity into the system to stabilise it close to the comfort zone of the Reserve Bank, and to stabilise interest rates in the overnight inter-bank market closer to the operative policy rate of the Reserve Bank. (IPA)