Appropriate Monetary Stance

The first quarter review of monetary policy announced by the governor of the Reserve Bank of India (RBI) – D Subbarao – should be commended for setting out an appropriate monetary stance against the backdrop of various risks and uncertainties, which are generally on the upside on several fronts. Monetary policy is essentially a short-term instrument; its transmission, unlike fiscal policy, is indirect and comes with a time lag. Thus, while fiscal policy can afford to be reactive, monetary policy perforce needs to be proactive, but herein resides the complexity of managing risks and uncertainties that makes the job of the monetary authority much more difficult, requiring more the finesse of art than the precision of science.

Risks, to a certain extent, are predictable and handled as such with some element of preparedness; but uncertainties can only be handled in a contingent manner, depending upon emerging situations. Therefore, some “ifs” and “buts” have to be taken into account in formulating an appropriate monetary stance. Overall, the RBI’s position is clear: maintain a monetary and interest rate regime consistent with the goals of price and financial stability, while supporting the return of the economy to its high growth path. This calls for (i) active liquidity management – so that the credit demand of the government is met (i e, smooth conduct of the large government borrowing programme) – while also ensuring the flow of credit to the private sector at viable rates, and (ii) being prepared to respond quickly and effectively through policy adjustments based on a vigil over inflation trends and signals (inflationary expectations).