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| Easy money should end on recovery |
| BS Reporter / Mumbai Jul 03, 2009, 00:21 IST |
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 Effort to maintain ample liquidity might be ‘sowing the seeds of the next inflationary cycle’
The Economic Survey has favoured a shift to monetary tightening when there is an economic upturn.
“The excess liquidity in the system should be sucked out once the economy gets sufficient momentum, in order to prevent building up of inflationary pressures”, the Survey, tabled in Parliament today, said.
On monetary policy, the Survey said the effort to maintain ample liquidity in the system might be “sowing the seeds of the next inflationary cycle.”
This is line with Reserve Bank of India Governor D Subbarao’s stance that a reversal of the easy-money policy, in play since October, is on the central bank’s agenda.
The Survey, however, balanced this by saying that RBI should ensure adequate liquidity and credit availability in the banking system.
Since October, RBI has taken a slew of measures to infuse liquidity into the banking system. These included sharp interest rate cuts and opening of the special refinance window to non-banking financial institutions.
In the last few months, RBI has cut the repo rate, the rate at which it lends to banks, by 425 basis points, and the reverse repo rate, the rate at which it absorbs excess liquidity from the system, by 275 basis points.
Also, the cash reserve ratio has been reduced by 400 basis points to pump in liquidity and spur demand. The Survey said the Reserve Bank had injected liquidity to the tune of Rs 4,23,000 crore in the system.
Banks are saddled with huge resources as credit offtake has remained subdued, reflecting moderation in demand. RBI is absorbing over Rs 1,00,000 crore daily through the reverse repo window.
On the limitation that banks faced in drastically cutting lending rates, the Survey said the impact of the steps taken by RBI had been more visible in bond and money markets. The effect on the credit market had been sluggish, it said.
While RBI has drastically cut the repo rate, banks have not been able to reduce their lending rates by the same measure. This is because they had raised deposits at higher rates to meet the demand for credit in the high growth period preceding 2008.
“These high rates have now come in the way of cutting lending rates at a pace consistent with the current outlook on inflation and the need for stimulating investment demand”, the Survey said.
In the coming months, the focus would continue to be on having a calibrated approach to using monetary policy for an early return to the high growth path, said the Survey. At the same time, efforts to build and preserve financial stability in the economy had to be high on the agenda, it said.
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