Although the Reserve Bank of India (RBI) expects inflation be reined in by the fourth quarter, it is conscious of the uncertainties of inflation projection. Between April and October 2012, the central bank has increased its March-end inflation forecast by 100 basis points (bps) to 7.5 per cent.
“The band is the reflection of our current assessment of risk. Post monsoon, we have risks coming from food prices. We had adjustments to administered prices and they may be more. The band reflects the range of assumptions as to what extent all adjustments might happen during the course of the year. We also had a lot of movement on the rupee which adds to uncertainty. The range of uncertainty has increased which reflects in the wider band,” said RBI deputy governor Subir Gokarn in the conference call for researchers and analysts on Wednesday.
In the second-quarter review of the monetary policy on Tuesday, the RBI raised the wholesale price index (WPI) inflation projection for March from seven per cent to 7.5 per cent. According to the central bank, before the WPI starts falling, it may be a tad over eight per cent. That’s why it has kept key policy rates unchanged in the second quarter review.
In the review, the central bank has decided to boost liquidity in the system with a 25 bps cut in the cash reserve ratio (CRR). CRR is the proportion of total deposits a bank has to keep with RBI as cash. After the cut, the CRR stands at 4.25 per cent of the net demand and time liabilities (NDTL), effective the fortnight beginning November 3.
However, despite the CRR cut, liquidity is expected to be tight. “We believe that the constraints that are operating in the liquidity system will persist for a few more months. Even the demand for currency might persist beyond the festival season, because the opportunity cost of holding currency is quite low. We thought that a CRR action will be more appropriate to respond to that, rather than open market operation purchase auction of gilts,” said RBI Governor D Subbarao.
According to Subbarao, monetary transmission will take place when liquidity situation is compatible. He said that one of the reasons for reducing the CRR was to “improve the transmission from the policy rates to the lending rates”. He expects that when there is comfortable liquidity in the system, credit will flow to those sectors that can use the existing capacity.
Subbarao said all the stakeholders in macroeconomic management, including RBI, is concerned about the quantum of fiscal adjustment and the quality of fiscal adjustment.