Growth’s settled in its groove,its high inflation we need to focus on

RBI didn’t really take any action in the recent review,especially on policy rates,despite high inflation.

DG: Remember,this was not a quarterly review. It was a mid-quarter review. After having taken a number of off-cycle actions,we felt the need to regularise the process. We had announced in July that rather than making monetary actions an unanticipated or unannounced process,we would schedule it and lend it some predictability. So,we have institutionalised a formal review mechanism. It’s more about communicating our thoughts,but not necessarily a scheduling of action. Whether it warrants an action is a judgement we take.

It is only now that the transmission mechanism of monetary policy action is showing signs of percolating down. Many banks have raised both lending and deposit rates and we saw this as a logical move following our monetary actions. We preferred to wait and watch. Hence we did not take any action in December. But,of course,liquidity situation was a source of concern. So,we brought down the statutory liquidity ratio (SLR) for banks permanently to 24 per cent. This released about Rs 48,000 crore into the system. The average deficit in the system was about Rs 1 lakh crore. The zone of comfort for liquidity is taken as +/- 1 per cent of net demand and time liabilities (NDTL). We are still maintaining a deficit,but that does not undermine our monetary actions as long as we keep an anti-inflationary stance.

In the current calendar year,first we had liquidity surplus. We were in the process of extracting excess liquidity. Then,since May-June liquidity has been in deficit. We have been in this situation since then. But,we have been able to control it such that there has not been any disruption in credit flow to the productive sectors. The balancing act has been to keep liquidity in the +/- 1 per cent of NDTL band. We hope to have this cushion till January-end. The open market operations are essentially a part of this.

There have been doubts about the instruments that the RBI has been using,which some say,sends confusing signals.

DG: It is an evolving system. We have to recognise the weaknesses in the transmission mechanism. Using two instruments definitely gives us more leeway. The objective,however,remains to keep inflation as low as possible at about 4-4.5 per cent and growth as close to trend as possible. We use a combination of action on rates and liquidity measures to achieve this because acting on the rates front alone does not give us a sense of adequacy. We are now reviewing the Liquidity Adjustment Facility operation to reflect the changes in the liquidity situation now. I think one should not take a static view of situation.

With industrial growth picking steam and inflation continuing to remain high,are we close to an situation where the economy was said to be overheating?

DG: One should not use to word overheating casually. In the first half of the current financial year,the economy grew at 8.9 per cent. But mind it,this was partly because of the low base of last year. We are growing when the global economy is still sluggish and there is a fair amount of excess capacity and unemployment in the West. Since our economy is globally interconnected,there still exists some leeway. As a result of liquidity in global markets,commodity prices are rising globally. In other words,liquidity is chasing alternate assets. Given India’s dependence on oil imports,there exists the possibility of a supply shock due to high energy prices. Hence the risks to inflation are on an upside. When inflation is over 4-4.5 per cent,we need to be watchful.

Can the government ease the liquidity situation by spending more?

DG: The government’s spending pattern is fairly fixed. The 3G auctions and disinvestment of government stake through IPOs has resulted in a windfall for the exchequer. There is a need to find how the government can accelerate spending,particularly when liquidity has become constrained. Besides,we also understand that there are structural drivers of liquidity. Bank credit is growing at a faster rate than deposits growth. It will take some time to rebalance this. High deposits will bring liquidity and the condition will start to correct. Given these structural issues,to make fund flow predictable for banks,we have decided about OMOs to the tune of Rs 12,000 crore a week. Such assured environment helps banks maintain their fund flows better.

With a strong first half growth,do you see more risks to inflation than growth now?

DG: Our forecast for the year at 8.5 per cent is likely to be achieved. The base affect will kick in the second half. The finance ministry estimates the economy to grow within a band of 8.5 per cent +/- 0.35 per cent. A growth rate of 8.5 per cent plus is looking quite realistic. So,growth is not so much of a concern now. Agriculture is also contributing to the GDP this year; growth is not coming entirely from services and industry. So,growth seems to have settled in groove. The focus has to be on inflation.