CREDIT POLICY July 27, 2010

The Policy Stance absorbed. Our calibrated actions to absorb surplus liquidity from
October 2009 onwards were reinforced by market conditions, which
Since October 2009, when it signalled the reversal of its policy evolved in early June 2010 and still persist. Consequently, overnight
stance, the Reserve Bank has cumulatively raised the CRR by 100 call money interest rates have moved towards the upper bound of
basis points and the repo and reverse repo rates under the LAF by 75 the LAF corridor, which is equivalent to effective tightening of rates
basis points each. The monetary policy response has been by 150 basis points. This has also brought the system closer to a
calibrated on the basis of India's specific growth-inflation dynamics point at which policy rate actions are likely to have greater traction.
in the broader context of persistent global uncertainty.
Current market conditions indicate that while liquidity pressures will
ease, the system is likely to remain in deficit mode for now. This
implies a significant change in the monetary operations, which has a
Thus, policy stance for 2010-11 has been conditioned by three
direct bearing on our actions. In a deficit liquidity mode, the repo
major considerations:
rate under the LAF has emerged as the operating policy rate. The
1. First, domestic economic recovery is firmly in place and is LAF operates in such a manner that as systemic liquidity alternates
strengthening. The 7.4 per cent growth in 2009-10 despite from surplus to deficit, even at the margin, the overnight call money
weak global growth and the insignificant contribution of the rates alternate between the reverse repo rate and the repo rate.
agriculture sector is a testimony of the resilience of the Indian This imparts volatility to call rates to the extent of the width of the
economy. The Reserve Bank's upward revision of the GDP LAF corridor.
growth projection for 2010-11 to 8.5 per cent (from 8.0 per
There is no unique way to determine the appropriate width of the
cent with an upside bias in April 2010) indicates that the
policy interest rate corridor. But the guiding principles are: (i) it
economy is steadily reverting to its pre-crisis growth trajectory.
should be broad enough not to unduly incentivise market
However, even as this is happening, prospects of a sustained
participants to place their surplus funds with the central bank; (ii) it
global recovery appear to be increasingly uncertain, with
should not be so broad that it gives scope for greater interest rate
possible adverse consequences for the EMEs, including India.
volatility to distort the policy signal. The challenge, therefore, is to
2. Second, inflationary pressures have exacerbated and become strike the right balance.
generalised, with demand-side pressures clearly evident.
As the systemic liquidity transits from an uni-directional surplus
Capacity constraints are visible in several sectors and pricing
mode to a bi-directional mode, it will have implications for the
power is returning to producers. Inflationary expectations also
effectiveness of monetary transmission. In the context of the
remain at an elevated level. Given the spread and persistence
changing liquidity dynamics, the operation of the LAF needs to be
of inflation, demand-side inflationary pressures need to be
studied. Accordingly, it is proposed to set up a Working Group to
contained.
review the current operating procedure of monetary policy of the
3. Third, despite the increase in the policy rates by 75 basis points Reserve Bank, including the LAF.
cumulatively, real policy rates are not consistent with the
Against the above stated backdrop, the stance of monetary policy is
strong growth that the economy is now witnessing. As
intended to:
articulated in previous policy statements/reviews, lower policy
rates can complicate the inflation outlook and impair ·Contain inflation and anchor inflationary expectations, while
inflationary expectations, particularly given the increased being prepared to respond to any further build-up of
generalisation of inflation. It is, therefore, imperative that we inflationary pressures.
continue in the direction of normalising our policy instruments
to a level consistent with the evolving growth and inflation ·Maintain an interest rate regime consistent with price, output
scenario, while taking care not to disrupt the recovery. and financial stability.

In this consideration, the liquidity situation plays a crucial role. It is ·Actively manage liquidity to ensure that it remains broadly in
well understood that transmission of monetary policy through rate balance so that excess liquidity does not dilute the effectiveness
actions works most effectively when liquidity is being injected into of policy rate actions.
the financial system by the central bank, rather than when it is being

1
Mid-Quarter Review of Monetary Policy Repo Rate

At present, scheduled policy announcements are made once in a It has been decided to:
quarter. In a rapidly evolving macroeconomic situation, however, a ·Increase the repo rate under the Liquidity Adjustment Facility
gap of a quarter between policy reviews can be too long. In recent (LAF) by 25 basis points from 5.5 per cent to 5.75 per cent with
years, there have been several occasions (April, June and immediate effect.
September-December 2008; January and March 2009; and March
and July 2010) when the Reserve Bank had to take off-cycle policy
actions in response to macroeconomic developments. While these Reverse Repo Rate
instances challenge the discipline of the quarterly schedule, they
It has been decided to:
also underscore the need for flexibility to manoeuvre. Many major
central banks in the world make monetary policy announcements ·Increase the reverse repo rate under the LAF by 50 basis points
more frequently ranging generally from 8 to 12 announcements in a from 4.0 per cent to 4.50 per cent with immediate effect.
year. It is, therefore, proposed to formalise what is already an
informal, internal process.
Cash Reserve Ratio
Accordingly, the Reserve Bank will now undertake mid-quarter
The cash reserve ratio (CRR) of scheduled banks has been retained
reviews roughly at the interval of about one and half months after
at 6.0 per cent of their net demand and time liabilities (NDTL).
each quarterly review. As per schedule, mid-quarter reviews will be
in June, September, December and March. They will be by way of a
press release, which will provide a rationale for either action or Expected Outcomes
maintenance of the status quo.
Monetary policy actions are expected to:
Mid-quarter Reviews are intended to communicate our assessment
a. Moderate inflation by reining in demand pressures and
of economic conditions more frequently. By instituting these, it is
inflationary expectations.
our intention to take the surprise element out of the off-cycle
actions. However, the Reserve Bank will have the flexibility, as b. Maintain financial conditions conducive to sustaining growth.
always, to take swift and pre-emptive policy action, as and when c. Generate liquidity conditions consistent with more effective
warranted by the evolving macroeconomic developments. transmission of policy actions.
d. Reduce the volatility of short-term rates in a narrower corridor.

Monetary Measures
Mid-Quarter Review of Monetary Policy 2010-11
On the basis of the current assessment and in line with the policy
The next mid-quarter review of Monetary Policy for 2010-11 will be
stance as outlined in Section III, the Reserve Bank announces the
announced through a press release on September 16, 2010.
following policy measures:

Bank Rate Second Quarter Review of Monetary Policy 2010-11

The second quarter review of Monetary Policy 2010-11, including
The Bank Rate has been retained at 6.0 per cent.
developmental and regulatory policies, is scheduled on November 2,
2010.

2
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