Other than the sub-optimal (excessive) reserve problem, this fuels liquidity. Hence the need for hardening rates and mopping up liquidity through CRR increases, since sterilisation doesn’t work. To justify this, one may as well invoke the inflation spectre by citing high CPI-based inflation and the unlikely eventuality of higher domestic petroleum prices materialising, particularly because earlier interest rate hikes don’t seem to have hurt industry (or investments) that much. However, goods exports have been hit by rupee appreciation. This is the background to the half-yearly review of monetary policy.

In all fairness, no one expected RBI to slash rates (bank, repo, reverse repo) yet. However, was there a need to hike CRR to 7.5 per cent? When the UPA government took over, CRR was 4.5 per cent. Indirectly, CRR hikes prevent commercial banks from reducing lending rates.

Since 1991, RBI has been adroit at managing forex shortages and crises. However, RBI’s monetary policy still hasn’t figured out how to manage foreign exchange surpluses. To compound the problem, other central banks have slashed policy rates (some have increased them too). But linked as we are to the dollar and the US economy, what happens if Federal Reserve cuts rates further? The capital inflow conundrum will worsen. And RBI’s monetary policy will continue to remain a square peg in a round hole.

The writer is noted economist