A non-disruptive policy action

By raising the policy rates by a modest 25 basis points, the Reserve Bank of India (RBI) has again managed a difficult balance between rising inflation risks and early signs of moderation in industrial activity.

While conventional policy choices have become extremely difficult in today’s globalised world, a firm anti-inflationary stance by RBI would go a long way in protecting the medium-term growth prospects of the country.

RBI has made it amply clear that there are no signs of a broad-based deceleration in growth, given the healthy levels of profit margins and bank credit growth during the fourth quarter of 2010-11. Continued robust growth in exports and the satisfactory progress of southwest monsoon so far in the first quarter of 2011-12 also support RBI’s optimism on domestic growth.

Credit markets have been functioning in an orderly fashion. A growth in non-food credit of around 20.6 per cent (year-on-year) in early June (above RBI’s indicative projection of 19.0 per cent) and moderation in the incremental non-food credit-deposit ratio to a healthy 80.5 per cent suggest growth is progressing without hurting financial stability.

Strengthening monetary transmission has also ensured that growth in overheated, interest-sensitive sectors has started moderating in the direction chosen by policymakers. At the same time, tighter liquidity conditions consistent with RBI’s anti-inflationary stance have not clogged up credit flows to the productive sectors.

While global factors do suggest a few risks, RBI’s gradual but consistent attack on inflation should help it achieve its inflation target in the second half of 2011-12 without creating any disruptions in the functioning of financial markets.

The writer is chairman and managing director, Bank of Baroda