The hawkish tone of RBI’s third quarter review of macroeconomic and monetary developments, just a day before the policy, had clearly set the tone for tightening. Since the annual policy review in April 2009, each quarterly policy has scaled up both the growth and inflation projections for 2009-10. In today’s policy, RBI with its growth projection of 7.5 per cent for 2009-10 is more optimistic than professional forecasters who pegged the growth at 6.9 per cent. A growth of 7.5 per cent in a year of severe monsoon deficiency is quite an achievement. RBI has also scaled up its year-end inflation estimate to a more realistic level of 8.5 per cent. It observed that inflation which was initially food driven is now getting generalized. Despite this, RBI did not go over the board in its inflation control endeavor. This largely reflects the concerns on the durability of ongoing recovery.
What will 75 basis points hike in CRR achieve? It will mop up Rs 36,000 crores of excess liquidity from the system. CRR hike notwithstanding, given the size of reverse repo operations (around Rs 80,000 crore daily), the liquidity will still remain ample. So a CRR hike will be more of a signal from RBI that it has transited to explicit tightening from implicit tightening which it had initiated in October, 2009. This should help in taming inflationary expectations.
We do not see this measure as putting pressure on interest rates in the near term. Further, the government borrowing programme for the current year is almost complete and therefore, no added pressure on the liquidity can be visualised at this stage. We expect 10-year government bonds at 7.4-7.6 per cent by March 2010.
With no pressure on interest rates the policy will not hurt the ongoing recovery. Given the hawkish tone of the policy and heightened growth and inflation expectations, liquidity mopping measures will be complemented by a rate hike in the next policy.
The next important event to watch out is the forthcoming budget. RBI managed a smooth government borrowing programme this fiscal. But as growth gains further momentum and private sector starts competing for funds, managing a heavy government borrowing programme will be very challenging.
With the monetary policy now in the tightening mode, it is important to begin a gradual exit from the fiscal stimulus to reduce the pressure from government borrowings.
(The writer is MD and CEO, CRISIL and Region Head, South Asia, Standard & Poor’s)