Apex bank to keep status quo

Below-trend gross domestic product growth (GDP) in the second quarter of 2011-12 and a poor start to the third quarter — October IIP was a reminder of the pain during the financial crisis — confirm India's economic slowdown. Even anecdotal evidence indicates the downtrend in economic activity witnessed lately is unlikely to reverse soon. Indeed, even GDP growth below 6.5 per cent in a few of the upcoming quarters would not surprise many. Thus, it is little surprise that the market has turned to the Reserve Bank of India (RBI) for some action to kick-start the investment cycle, since the scope for fiscal measures is limited.

While nobody expects a reduction in the repo rate this week, a lowering of the cash reserve ratio (CRR) is being talked about as the first line of defence in containing the slide in growth. The banking system's liquidity deficit is often used as an argument in favour of such a move.

However, recent comments by RBI indicate the CRR is also a monetary policy tool, and it would signal a reversal of its monetary policy stance. With inflation in November still close to nine per cent, we believe RBI would not be in a hurry to signal a change in stance. We expect it to maintain status quo on December 16, even though growth concerns are likely to occupy more space in the policy statement. Slower growth should eventually squeeze out excess demand-side inflationary pressures, which RBI has long been trying to address. In terms of supporting-banking system liquidity, RBI is likely to continue to employ tactical tools such as buying government securities through open market operations. Thus, a reversal in monetary policy would most probably have to wait until 2012.

Anubhuti Sahay
Senior economist, Standard Chartered Bank