Reading the signals

Is it careful signalling that the Reserve Bank governor has done, or is Dr Reddy waiting for some conceptual clouds to lift? Consider the following: the GDP growth rate in recent quarters has consistently outdone the RBI's forecasts, and the central bank seems to be adjusting to the idea that it has to change its monetary goal-posts. In other words, aiming at 15 per cent growth in money supply will not do, if money is not to act as a constraint on growth. Commercial bank credit, after all, is growing by more than 30 per cent for the third year in a row""with some of it going into capacity creation that will prevent supply side shocks. And what if GDP growth this year is going to be more than the 8 per cent that the RBI now expects? Should there then be a further opening of the money tap? In his policy statement, Dr Reddy talks of the possibility of a structural shift in the credit market, because of the huge growth in retail credit. And he notes that the level of bank credit in relation to GDP is very low in India, much lower than many developing countries including China. All of that points to the need to open the tap.

But then, there are those factors that would mitigate against such a step. For instance, the governor concedes that demand pressures may be pushing up prices beyond the target 5-5.5 per cent level, but he qualifies that by pointing out that the problem here may be supply shortfalls and not monetary policy. Also, he sees a general softening of prices, including for oil. If the inflation rate drops, wouldn't monetary tightening be pointing the wrong way? The one ambiguous signal of excess liquidity is the asset price bubble, which does not show up in the inflation figures and which is certainly credit-facilitated. Also, it could be argued that any central bank governor should get nervous when something like half a million mobile handsets are bought on a single day (as apparently happened at Diwali this year), with record car sales to boot. If caution is to be the watchword, why not signal it?

The problem with that is that the US economy has slowed quite dramatically. While other parts of the world economy are still ok, it is clear that US short-term interest rates will be flat and may even fall. Since money moves across borders, can Indian rates be raised when US rates drop? Will that not encourage even more money to come into India? In other words, the dissonance between the Indian business cycle and its American counterpart poses its own challenges. The governor is refreshingly candid when he admits that assessing the extent of excess demand has become complicated.

Faced with this diverse set of issues, it should not surprise that Dr Reddy has taken steps that seem to point in different directions, leaving analysts in the role of the blind men of Hindoostan trying to get the hang of the elephant. He has both raised and not raised short-term rates, as was commented yesterday. Somewhat contrarily, then, he has taken steps to increase liquidity-given greater access to international capital and a little depth to the debt market. On the margin, these may add a percentage point or two to the available stash of cash with banks. The message, if one can be distilled, seems to be that money will be made available since the system seems to need it, but at fractionally higher cost""to signal that there are danger points on the map and that the RBI is nervous about the rate of inflation climbing beyond current levels.