RBI’s Annual Monetary Policy Review 2008-09

By Amol Agrawal

RBI announced its monetary policy for the financial year 2008-09. The highlights
are here and the detailed policy is here.

The much awaited decision on interest rates is:

 Bank Rate, Reverse Repo Rate and Repo Rate kept unchanged.
 Scheduled banks required to maintain CRR of 8.25 per cent with effect from the fortnight
beginning May 24, 2008.

RBI didn’t change the policy rates but just increased CRR. This implies RBI is more
concerned over excessive liquidity and believes that interest rates have peaked. Higher
policy rates could further slow the growth.

Prior to the policy, I had pointed that RBI was into a dilemma. The markets expected that
inflation is going to be around 7%-7.5% over 2008-09 and this would warrant a hike in
interest rates. RBI’s preferred inflation is around 4.5% to 5% and the expected numbers
are much higher. But growth rates have moderated across sectors (it is still high relative
to the world) and a further hike could slower growth further.

So, any change in rates could harm either inflation or growth. Still, the
Bloomberg/Reuters Polls showed RBI would take a hawkish stance over rising inflation
and hike rates. By not increasing rates RBI is trying to balance growth and inflation.

What however worries me is that RBI expects inflation to be around 5.5% in 2008-09
which looks really difficult looking at the present numbers

 Inflation to be brought down to around 5.5 per cent in 2008-09 with a preference for
bringing it close to 5.0 per cent as soon as possible. Going forward, the resolve is to condition
policy and perceptions for inflation in the range of 4.0-4.5 per cent so that an inflation rate of
around 3.0 per cent becomes a medium-term objective.

RBI has also announced prudential measures to address banks exposure to commodity
markets and look at special purpose vehicles/off balance sheet activities of banks.

I will keep adding to this post as I am still reading the report.

The viewers should also take a look at Macroeconomic and Monetary developments
released yesterday.

Addendum:

Another important point to note is that RBI’s targetted growth in Money Supply (M3) is
16.5% -17%. Chapter 3 of Macroeconomic and Monetary developments shows the M3
growth. It is about 21% in 2007-08. Hence, RBI might be taking some more measures to
suck excess liquidity from the system.