New Delhi, April 29: There are short-term relief, possibility of medium-term pain and two big questions in RBI’s keenly anticipated monetary policy review which was marked by a 0.25 percentage-point hike in the cash reserve ratio (CRR) to 8.25%.

CRR determines the amount of money banks have to keep in deposit with RBI and higher CRR means less funds for banks to lend. RBI is arguing there’s too much cash sloshing around in the system fuelling inflationary expectations. Inflation as measured by the wholesale price index has been 7%-plus in recent weeks, a three-year high.

CRR was increased earlier this month and has climbed from 7.5 to 8.25% in a few weeks. The CRR hikes will take around Rs 27,000 crore out of the banking system, forcing banks to rethink lending strategies but it needn’t immediately make them raise rates, including those on home loans. That’s the short-term relief.

Had RBI raised its key rates — especially the repo rate, the rate at which the central bank lends to commercial banks — there would have been quick impact on interest rates. But the repo has been kept at 7.75%. Big public sector banks like SBI said within hours of RBI’s announcement that rates will be left unchanged. The stock market responded positively. Home loans got a minor boost as well. RBI has reduced risk weight on home loans up to Rs 30 lakh. The earlier cut-off point was home loans up to Rs 20 lakh. A major chunk of home loans are in the Rs 20 lakh to Rs 30 lakh category. So banks may look at this segment more keenly now.

But banks have a problem. The CRR hikes and RBI’s statements make clear the central bank wants tight monetary conditions. Money supply grew by 20.7% in 2007-08. RBI wants the growth rate to be 16.5% this fiscal year. Tight money conditions mean banks have to ration lending. Therefore, in the medium term, there’s no way to predict that interest rates — the price of credit — won’t increase. Plus, when credit is scarcer, small and medium companies are typically hit most, and they form the majority in the manufacturing sector. Thus the possibility of medium-term pain.

Indeed, there’s a big question from this whether all of RBI’s numbers add up. The central bank has pegged GDP growth for 2007-08 at 8-8.5%. But it wants money supply growth to slow down sharply. There’s good reason to be skeptical whether this rate of economic growth can be supported by a much slower money supply growth.

For the second question, look at America. The US Federal Reserve — America’s central bank — is widely expected to cut US interest rates by 25 basis points on Wednesday. RBI didn’t hike rates but the American rate cut will increase the difference between US and Indian rates. That means more incentive for dollars to flow into India, to take advantage of assets bearing higher interest rates. These inflows mean fewer rupees are needed to buy a dollar; the rupee appreciates. But RBI generally wants the rupee to not appreciate. But that’s only possible if there are more rupees in the system to sterilize the impact of more dollars. That’s what RBI does.

So the big question is: why does RBI both increase liquidity (to combat impact of dollar inflows) and mop up liquidity (to curb inflationary expectations)? Why not instead allow the rupee to appreciate, which means no additional liquidity, and therefore have more policy flexibility on balancing growth and inflation?