Growth is a bigger wor

MID-TERM MONETARY POLICY 2008-09/ VIEWPOINT

While the Reserve Bank of India (RBI) chose not to change the key rates in its quarterly policy review today, the last three months have witnessed perhaps the most abrupt changes in the country's monetary policy in living memory as interest rate increases have given way to unprecedented rate reductions. The explanation partly lies with the eruption of a full-blown financial crisis in the developed world although events closer home shouldn't be ignored either.

The replacement of Dr Reddy with Dr Subbarao at the helm of RBI represents a major shift in the bank's policy regime. In essence, a change from a governor who preferred to err on the side of the hawks to one who, in his short stint, has shown to be extremely responsive to what was beginning to resemble a US/European style of liquidity squeeze in the country.

 

In less than two weeks, the RBI announced cuts in cash reserve ratio totaling 250 bps – the biggest such reduction in the last 36 years, effectively reversing in two weeks what it took Dr Reddy a year to deliver. A full percentage point has also been lopped off the repo rate, first such cut since early 2004, and likely to be followed by further action ahead.

The good news is that such a dramatic monetary loosening looks to have helped unblock the interbank market for overnight lending. Unfortunately, longer maturity lending remains troublesome. Though on its way down, inflation is still in double digits and the job of the central bank is to be forward looking. Now, the bigger issue is not inflation, it’s how to tackle weaker growth.

Nevertheless, a growth target of 7 per cent should be interpreted as a cyclical slowdown rather than anything more structural. I remain confident that the economy will make a comeback by 2010.

Naina Lal Kidwai, Country Head, HSBC India