Bankers and the markets on Monday read signals that the Reserve Bank of India was likely to continue its tight money policy in Governor YV Reddy's statement that India is vulnerable to oil and foodgrain price shocks.
Reddy was speaking at the inauguration of the golden jubilee celebrations of the Forex Exchange Dealers' Association of India in Mumbai.
His comments, though made in a different context, come just weeks ahead of the second quarterly review of the monetary policy for 2007-08, scheduled for October 30.
With wholesale price inflation at 3.42 per cent for the week ended September 22 well below RBI's annual target of 5 to 5.5 per cent, bankers are hoping the Central bank will not raise the cash reserve ratio, the proportion of deposits banks must keep with RBI.
CRR increases have raised banks' cost of funds, pushing up lending rates 3 or 4 percentage points over the past year and cooling credit offtake.
Lower inflation, however, is widely attributed to the "base effect" -- or the fact that inflation in the corresponding week of 2006 was high -- and was expected to wear off in a couple of months.
The RBI severely tightened monetary policy in the preceding 10 months since it began raising reserve levels and interest rates in October 2004.
Since December 2006, the RBI has raised CRR by 200 basis points to 7 per cent and the repo rate, the rate at which the Central bank lends to banks against government securities, by 50 basis points to 7.75 per cent.
"The RBI is clearly worried about high inflationary expectations and the tight monetary policy stance is likely to continue for a longer period," said a debt analyst.
Reddy also argued that India's continued vulnerability to oil and food price shocks indicated that the country was not ready for a currency stabilisation or sovereign wealth fund.
Given India's record reserves of $250 billion, Reddy said it was necessary to view the concept of "excess reserves" from several angles, including from the perspective of possible real sector shocks to the current account, the gap between trade receipts and import expenditure, and the nature of capital flows.
A stabilisation fund is meant to achieve medium-term macroeconomic stabilisation objectives to meet the impact of volatility in export earnings.
Wealth funds are special-purpose investment vehicles created to manage national savings to generate higher returns.
Reddy said India could not have any "windfall" gains for creation of a currency stabilisation fund in the absence of a dominant "exportable" natural resource like oil for the Gulf countries.
Also, the continuing current account deficit makes it impossible to set up a sovereign wealth fund. India has to ideally await a "more comfortable current account" and "significantly improved fiscal" situations, Reddy said.
