The annual announcement of monetary and credit policy by the Reserve Bank of India has come amid a rather complicated macro-economic situation.
Growth and inflation appear to be pulling in opposite directions, the former indicating a loosening of the purse-strings, the latter a tightening.
The inflationary pressure itself is clearly from the supply side, not directly amenable to control by traditional monetary policy instruments.
Despite these reservations, the RBI had increased the cash reserve ratio by 50 basis points on April 17 to appease concerns about inadequate responses to inflation, however inappropriate these responses might be.
So the expectations from Tuesday's package veered towards a hike in the repo rate, the stronger of the two instruments that the RBI has used of late, although there was a significant view that this would not be done in recognition of the concerns about growth.
In the event, the RBI has hiked the CRR a further 25 basis points but left its benchmark interest rates unchanged.
While this has surprised the markets, which have reacted with relief, the question is whether this is an appropriate response to the current circumstances.
Most definitely, yes. This newspaper had advocated maintaining the status quo on interest rates on the grounds that a hike would do more harm to growth than it would help control inflation. Inflation today is a truly global phenomenon and no individual government can claim to be able to control it fully.
However, the recent measures by the government, comprising customs duty cuts and restrictions on exports, will probably be effective in reining in price increases in the short term.
In fact, even as the monetary policy was being announced, the finance minister announced further measures in Parliament, imposing export duties on steel products and raising the duty on higher-priced cement.
Even as the domestic supply scenario for these commodities responds to the new regime, there is good news on the food front by way of the forecast of a normal monsoon.
These factors collectively point to an easing of inflationary pressure, though with the risk that global forces will offset all these gains -- which the RBI and the finance ministry can do nothing about.
Against this backdrop, the priority given to minimising the growth deceleration by not raising interest rates was the most sensible approach.
The CRR hike is potentially restrictive, of course, but it will only kick in if growth accelerates to a rate which puts pressure on liquidity because of increased demand for credit.
As long as the growth rate remains in the range that the RBI forecasts -- 8-8.5 per cent -- liquidity is unlikely to become a constraint. This is a good defensive stance, protecting against the likelihood of demand pressures exacerbating supply-side inflation.
In addition to its sound macro-economic stance, the central bank's announcement also contains a number of structural measures for market development. An over-the-counter mechanism for rupee derivatives has been proposed, as also the introduction of currency futures in eligible exchanges.
Both will contribute to widening access and lowering the costs of hedging exchange rate risk. STRIPS, which allow investors to separately trade the principal and interest components of securities, will be introduced, again giving different classes of investors a wider choice amongst fixed-income instruments.
These are all measures whose time has long come and it must be hoped that they are implemented with all possible speed.
