The Reserve Bank of India has left interest rates unchanged while conveying grim warnings of the economy facing more potent and real inflationary risks and expectations due to international food, oil and metal price pressures, which would call for swift and even unconventional responses as the situation evolves. Announcing the Monetary and Credit Policy for 2008-09, the central bank attaches high priority to price stability with anchored inflation expectations and orderly conditions in financial markets while sustaining growth momentum. RBI has also increased the reserve ratio as part of its liquidity management measures.

The Policy statement spoke of active demand management of liquidity through appropriate use of CRR stipulations and open market operations. It emphasizes credit quality and credit delivery in the pursuit of financial inclusion. In the context of possible losses of banks from derivatives and newer instruments as has happened widely in USA, Europe and some Asian countries, emanating from the US sub-prime mortgage market crisis, RBI would review prudential guidelines for specific-off-balance sheet exposures of banks. It would also undertake supervisory review of the bank’s exposure to the commodity sector.

In its overall assessment, RBI says the pick-up in inflation has mainly emanated from supply side pressures such as the one-off increase in domestic prices of petrol and diesel to partially offset global crude oil prices increase over the year and rising prices of wheat and oilseeds and the adjustments in steel prices in March. Though the upsurge in inflation in India has occurred when global energy, food and other commodity prices are volatile and at historically elevated levels, there are concerns that demand pressures, which have been reasonably contained so far, are being coupled with supply-side factors which, if not temporary, could impact domestic inflation significantly.

RBI’s Policy has belied expectations of monetary tightening via interest rates and has left the Bank Rate unchanged at 6 per cent as well as the policy rates, and reverse repo rates at 7.75 and 6 per cent respectively. Such actions have to be based on evaluation of emerging developments on a continuous basis. At the same time, there is need to demonstrate determination to act decisively, effectively and swiftly to curb any signs of adverse developments in regard to inflation expectations.

RBI said with significant shifts in both global and domestic developments in relation to initial assessments, the dangers of global recession have increased at the current juncture although consensus expectations do not rule out a soft landing. On the domestic front, though the growth outlook remained positive till January 2008, since then the risks to inflation from upside pressures from the prevailing global price levels in food, crude and metals have become more real than before. Global financial market uncertainties and unusual policy responses of major central banks provide some indications of the threats to global growth and stability that loom over the near-term horizon. RBI also referred to heightened uncertainty surrounding the outlook on capital flows to India, complicating the conduct of monetary and liquidity management. In view of the strong fundamentals of the economy and massive injections of liquidity by central banks in advanced economies, there could be sustained inflows, as in the recent past.