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Monetary policy 2005: It's crucial! - Views on News from Equitymaster
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  • Apr 27, 2005

    Monetary policy 2005: It's crucial!

    With the RBI's annual credit policy announcement (monetary policy) on the cards (to be announced on 28th April), anticipations are running high, as to what direction will the policy provide for India's growth going forward. Prior to the policy announcement, attention always converges on what the RBI will do/not do with regard to the key rates, the bank rate and the CRR (cash reserve ratio). Much in debate is the fact whether the Reserve Bank of India (RBI) governor will reinstate his view regarding hardening of interest rates to tame down the rising inflation. Before going on to the key expectations from the monetary policy of this year, let us take a look at what was pronounced in the policy for 2004-05 (including the mid-term policy).

    Highlights of Monetary Policy 2004-05

    May 2004

    • The RBI proposed to expand the scope of the infrastructure sector to include sectors like construction relating to projects involving agro-processing and supply of inputs to agriculture, construction for preservation and storage of processed agro-products, and construction of educational institutions and hospitals.

    • The RTGS (Real Time Gross Settlement) system was to be implemented by June 2004, thus paving way for the stock markets migrating into the T+1 system.

    September 2004 (Mid-term policy)

    • In a bid to tame the runaway inflation, the RBI increased the CRR in September 2004 from 4.5% to 5%. The central bank's sudden move was to suck around Rs 70 bn out of the banking system.

    • The RBI also cut the interest rate that it pays to banks on the cash balances from 6% to 3.5%. This was to discourage banks from parking additional funds with the RBI and thereby lend more.

    Expectations from Monetary Policy 2005-06

    Here are some expectations from this year's monetary policy based on our interaction with industry sources.

    • With the revival in credit demand and inflation under control, it is anticipated that the RBI will not hike the CRR rates any further. This is in tune with the central bank's reiteration from time to time that it would continue to pursue its medium-term objective of reducing CRR to its statutory minimum of 3%, while retaining the option of tinkering with it as and when required, to manage liquidity.

    • The RBI is also expected to provide some leeway to banks on priority sector lending. Bankers are of the view that any infrastructure-related project, whether at the national level or the regional level, should come under the priority sector lending category. This will spur investments in infrastructure, which will boost economic growth.

    • On the money markets side, what is desired is flexibility in the liquidity adjustment facility (LAF). Variable repos may be brought in to manage the liquidity crunch or the abundance that occur from time to time.

    • Trading on repoable securities may be introduced in to allow the players to take advantage of the price increases.

    What now remains to be seen is which of these expectations are complied with in the monetary policy of 2005-06. The same will also a give a direction to the financial sector's moves on credit disbursements and interest rates. While money supply is not completely controllable by a central bank, the monetary authority has to decide the timing and magnitude of sterilisation and enforce it to ensure optimal liquidity and a rate of growth of money supply that is not well outside the targeted range. The ball is now in Dr Reddy's court to design the Indian economy's future growth trajectory. Over to him!



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