The cash reserve ratio (CRR) is also retained at 4 per cent of banks’ net demand and time liabilities, given an improvement in liquidity conditions. With repo rate unchanged, other policy rates would remain as they are, reverse ratio at 6.75 per cent and both the Bank Rate and the Marginal Standing Facility (MSF) at 8.75 per cent each.

Dr Rajan’s reasoning for status quota is that the high inflation, at both WPI and CPI levels, is due mainly to food prices, especially vegetables, on which indications are that prices may be turning down. He also expects the disinflationary impact of recent exchange rate stability (with “robust inflows” into swap windows opened by RBI) to play out into prices.

Another moderating factor could be the slowdown in services growth and lagged effects of effective monetary tightening since July. Dr Rajan prefers to wait till the “uncertainty surrounding the short-term path” of inflation is cleared. Given the “weak state” of the economy, he has concluded that any “overly reactive” policy action is inadvisable.

However, Dr Rajan assures that RBI would remain vigilant to act, including on off-policy dates, if softening expectations do not materialise and translate into significant reduction in the next round of data releases. RBI would also be on alert to any disruption in external markets from tapering of quantitative easing by the US Federal Reserve, which was expected to make an announcement at the end of its two-day meeting late on December 18.

The Governor’s opting for more time before determining the course of monetary policy would have provided great relief to the markets and welcomed by both Government and business and industry though any tightening of policy rate by the central bank does not get transmitted to the lending rates of commercial banks.

In the mid-quarter review, Dr Rajan has noted robust growth of agricultural activity and improvement in net exports but he sees headwinds to growth from industrial weaknesses continuing into third quarter, services sector slowing and subdued domestic consumption demand.

Tightening of expenditure to meet deficit projections of the Finance Minister, he points out, would also add to headwinds. Therefore, he has emphasised the critical importance of revival of stalled investment, especially in projects already cleared by the Cabinet Committee on Investment.

Dr Rajan has not minimized the threat to growth and financial stability from entrenched inflation at elevated levels and also the risks of exchange rate stability. But on the external front, at any rate for the present, he has drawn an encouraging picture with the narrowing of trade deficit in the latter half of 2013 with positive export growth and contraction in oil and non-oil imports.

The current account deficit (CAD) is now assumed to be lowering to more sustainable levels of 3 per cent of GDP or less. Helped by the NRI deposit inflows, the reserves have also been augmented with which it should be possible to finance external payments and provide stability to the foreign exchange market.

Looking ahead, Dr Rajan says,these favourable developments should help to build resilience to external shocks. Though his policy stance in this mid-quarter review could be perceived to be soft on inflation, “RBI can help guide market expectations through a clearer description of its policy reaction function”.

At the same time, RBI would not be lowering its guard to act if inflation does not fall, and it would step in to stabilize inflation expectations to enable a conducive environment for sustainable growth.

Dr Rajan’s latest policy move, though unexpectedly dovish, will no doubt be critically analysed in the coming days with all the mass of inflation data thrown up in recent years and the clear rising trends that have already been observed over the last few years. Should his expectations of softening of inflation, namely, food prices, which has to be both significant and durable, not materialize, he might be held to have mistimed his gesture.

Also, Dr Rajan, as a leading economist, believes in disinflationary processes setting in from a variety of factors, apart from a good monsoon and kharif harvest, to lower inflation expectations. Even with bright crop prospects, food prices have continued to rise so far. There is no let-up in market prices for cereals, though indexwise, the pace of increase may be pointing a downtrend in some cases over the corresponding period of the previous year.

Food prices as a whole have been moving up sharply in recent weeks. Government has no effective measures to tame food prices nor does the Finance Minister Mr Chidambaram think that monetary policy which he calls “a blunt instrument” could be the solution. That is a road to nowhere beyond living on hopes. RBI pause at this moment is certainly not taken as an endorsement of what the Finance Minister has said.
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The other disinflationary impact Dr Rajan has referred to is the industrial and services sector slowdown which would reduce demand and therefore push down prices. Industry is in a state of virtual stagnation for two years but there are hardly any manufactured products whose prices have gone down. Manufacturers have fully used up their pricing power as reflected in the ever-increasing retail prices.

However, Dr Rajan would be intervening sooner than expected with the possibility of some of the calculations underlying his mid-quarter review going awry and he may also be forced to react to any volatility in foreign exchange markets in the wake of Fed's decision on taper, even marginally to begin with, at the start of the new year. The spillover effects would be felt on foreign exchange markets with the possibiliy of reduced capital inflows.(IPA)