In its second quarter review (July-September) - also a mid-year look - RBI has kept unchanged the bank rate (6 per cent) and key policy rates of repo (4.75), reverse repo (3.25) and the cash reserve ratio at 5 per cent, though it noted that the banking system was awash with liquidity since November 2008.

As its “first phase” of exit from the present exceptionally accommodative stance, the statutory liquidity ratio (SLR) which was lowered to 24 per cent is being returned to 25 per cent of the net demand and time liabilities (NDTL) from November 7, 2009. Further, the limit for export credit refinance facility which was raised to 50 per cent of eligible outstanding credit is also being returned to the pre-crisis 15 per cent.

RBI has also kept unchanged its first quarter review target of GDP growth at 6 per cent with upward bias but has sharply raised its earlier inflation projection of 5 per cent to 6.5 per cent by end March 2010. The upside risks have materialised for inflation, it says, keeping in view the monsoon deficiency, the global trend in commodity prices ahead of global recovery, volatile oil prices, and the domestic demand-supply balance in relation to prices of food and food products, While WPI inflation has entered positive territory, the consumer price index (CPI) has remained close to or above double-digit. It was 11.72 per cent in September as against WPI at 1.21 per cent (reflecting the base effect now fading) as on October 10.

Indeed there is considerable concern evident in both RBI's overall assessment and the Economic Outlook for 2009/10 of the Economic Advisory Council, boith underlining the food price inflation as a major policy concern calling for effective supply-side actions. While RBI has been counselled not to switch gears in order to “save” growth, Government measures on controlling prices are yet to have any impact at all.

Outlining its current stance RBI says it would keep a vigil on trends in inflation to be prepared to respond swiftly through policy adjustments to stabilise inflation expectations. The liquidity situation would be closely monitored and managed actively to ensure that credit demands of productive sectors are adequately met while also securing price and financial stability. The monetary and exchange rate regime would be maintained consistent with price stability and financial stability and supportive of growth process. The monetary expansion target of 18 per cent set earlier has now been lowered to 17 per cent. This would take care of further borrowing requirements of government and commercial sectors.

Governor D Subba Rao in his second quarter review statement says, “RBI is mindful of its fundamental commitment to price stability. It will continue to monitor the price situation in its entirety and take measures as warranted by the evolving macro-economic conditions swiftly and effectively”.

He points out India with its supply-constrained economy is unlike most other countries which do not face immediate risks of inflation. Supply constraints would re-emerge here and India is also running sizeable deficits, especially fiscal.

Though both monetary and fiscal expansion has been undertaken in India on an unprecedented scale to stimulate the economy, as many countries caught in the global crisis have done, it is also time to plan for orderly exit when growth picks up. The challenge for RBI, the review says, is to support recovered process without compromising on price stability. ”Growth drivers warrant delayed exit while inflation concerns all for early exit”. While premature exit could detail fragile growth, delayed exit could potentially engender inflation expectations, it adds.

On the fiscal side, RBI has called for a “responsible, credible and time-bound fiscal adjustment” and says there is critical need to downsize the Government borrowing programme so as to help sustain a moderate interest rate regime. This is crucial for investment demand to pick up, which hinges on long-term growth prospects. For the current year, the Centre's borrowing programme had been completed to the extent of 80 per cent till October 16 (Rs.319,911 crores), RBI said.

On the external side, the position has become comfortable with resumption of capital flows which helped to finance current account deficit in the first quarter and augment reserves (inclusive of valuation changes) by 32 billion dollars in the current year (as against the decline by 20 billion dollars in 2008/09). Reserves stood at 284 billion dollars as on October 16 and this included five billion dollars from IMF's special allocation of 250 billion dollars in SDR to its 185 member-countries.

The Reserve Bank has had to frame and fine-tune its midterm monetary and credit policy for the second half of 2009/10 - one of the most difficult years for macro-economic management after the 1991 crisis - in the face of risks weighing heavily on the downside such as the emergence of strong inflationary pressures even as private consumption and investment demand have remained subdued dampening the growth outlook. Thus, RBI has had to manage a trade-off between maintaining its accommodative monetary stance to support growth on the one hand and reining in inflationary expectations, given the elevated double-digit consumer price inflation, on the other.

RBI says in its latest economic survey that high CPI inflation, especially food articles poses a “major risk to inclusive growth” since it could potentially lead to erosion of rural incomes (especially in the drought year plus flood devastation in some states). Persistent high CPI inflation could also lead to wage/cost push inflation because of pressures for wage and price revision as well as revision of minimum support prices of foodgrains. From the standpoint of monetary policy, increased inflation expectations in the face of sustained high inflation in essential commodities would be the key challenge.

However, Government concerned more with shoring up the economy, had left the central bank in no doubt, both through the Finance Minister and other high level functionaries, that it was still early to withdraw its highly accommodative monetary stance considering the emerging signs of recovery as a result of expansionary fiscal and monetary policies. Government also feel that these signs could still be tentative till global economy overcomes the worst recession that gripped advanced nations and could last at least till the end of 2009. (IPA Service)