The half-yearly monetary policy review of the Reserve Bank of India announced on Tuesday can be seen as the debut of the new governor, Raghuram Rajan. The review had one clear message. This was the priority that the RBI, under its new governor, was giving to tackling inflation. This priority was indicated by a number of important measures. The RBI raised the repo rate — the rate at which the central bank provides short-term liquidity to banks — by 25 basis points to 7.75 per cent. This is the second time the repo rate has been hiked since Mr Rajan assumed office in early September. The hikes are obviously aimed at squelching inflation. Mr Rajan also reduced the marginal standing facility rate by another 25 basis points. The MSF is used by banks to access overnight funds from the RBI when they face a severe cash shortage. As a result, the liquidity adjustment facility acquires the width of 200 basis points. The overall direction seems to be to inject greater liquidity into the market. The review represents an attempt to return to the situation that prevailed before emergency measures were put in place in the middle of July this year.
There are other indicators in the review. It is logical to expect that given where the LAF stands, adjustments in the repo rate will become a critical policy instrument. In this context, the importance assigned to handling inflation will mean that the repo rate can only move upwards in the future. It is significant that the review measured inflation by the consumer price index; this probably means that the consumer price index will be the lever for future policy decisions. Mr Rajan has thus placed his priorities on the table. He has also inspired an enormous amount of confidence and expectation. It will be recalled that on taking over, Mr Rajan spoke of a “hundred small steps’’ rather than of dramatic breakthroughs. This honesty, that he has no magic wand, has earned him goodwill. Industrialists and investors have reasons to be unhappy with the decision to hike the repo rates and with the prospect that the rates might be raised further in the future. But they must acknowledge that Mr Rajan is also trying to balance the hike in the repo rates with other measures like a cut in the MSF rate, which lower the cost of short-term borrowings. The review contains signs that the economy is now being seen as returning to some kind of normalcy.