The package announced by the RBI this weekend will go quite a way in easing rupee liquidity in the coming days. Some of the damage done owing to the credit policy announcement has been addressed. However, if the global situation remains tight, further steps will be needed to address the dollar liquidity problem and the consequences for rupee liquidity. The RBI needs to change its communication strategy, it needs to reform the operating procedure of monetary policy and it needs to change its currency policy.

The RBI has, in the past, in 100-page policy statements favoured ambiguity in communication. Financial markets were understandably spooked when the RBI released a credit policy statement with a do-nothing stance, with text that was often designed to obfuscate, and with talk of reducing inflation and of lowering credit growth that was out of touch with the changed realities. The need of the hour is clarity of thought and clarity in communication. The new RBI statement makes progress: it clearly says that inflationary pressures have abated and it will do all it takes to provide liquidity to the economy. With this statement, we are told that the RBI will now focus on growth and maintaining financial stability. Commentators have, in the past, pointed out that RBI policy statements need to be shorter and clearer. The RBI statement on Saturday is an example of how clear communication is achieved. It should be the way future communication by the RBI is done.

While some of the damage caused by the credit policy will be undone by the package, the markets are wary, given the flip-flops of recent weeks. The RBI began with an activist stance of understanding and addressing the global financial crisis. Then came the credit policy, in which the RBI said nothing should be done, which was followed by a squeeze in the money market. It may thus take a while for banks to feel comfortable about liquidity. The RBI needs to articulate a clear operating procedure of monetary policy, one which will definitively ensure that short-term, risk-free interest rates in the economy will not go outside the stated corridor.

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