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n the first quarter review of the Monetary Policy for FY 2011-12, the Reserve Bank of India has prescribed double the anticipated dosage of anti-inflationary remedy convinced of the efficacy of its diagnosis and treatment of the problem over the past 15 months and its prognosis of substantial cure by the end of the year.

Accordingly, the baseline projection of real GDP growth is retained at 8 per cent, as set out in the May 3 policy statement, while the baseline projection for WPI inflation for March 2012 is revised upward from 6 per cent with an upside bias, as indicated in the May 3 policy statement, to 7 per cent.

Macroeconomic review

The review has showed that economic growth is moderating with more downside risks. Inflation remains high with further near-term upside risk. In addition, there are risks to baseline growth and inflation emanating from both local and global factors.

Against this grim backdrop, there are signs of hope. Corporate sales are robust though profits are moderating. Private consumption demand continues to be strong. Exports momentum is strong along with inflow of invisibles.

RBIhad raised policy rates by a cumulative 425 basis pointsperiod of 15 months.While the RBI has thoughtfully carried out this tightening through measured baby steps, the banks have carried out the transmission in a gradual and sequential manner keeping in mind the interests of the savers and investors, without upsetting growth.

Demand management

The successive monetary tightening would appear to have indeed succeeded in moderating demand and some components of general inflation where the supply-side resistance is not too strong.

Even at this rate, the general expectation is that inflation will not moderate until after December 2011 when the impact of the factors and uncertainties underlying growth and inflation such as the effect of monsoon, structural reforms to ease supply, financial deficit management, global commodities prices, and so on, will be clear.

Till such time it is necessary, according to RBI, that monetary policy continues with its anti-inflationary bias to anchor inflation expectations. Therefore, it has thought it expedient to hike the policy rate by 50 bps against the market expectation of 25 bps to reinforce the cumulative impact of past actions on demand. Further doses of increase may also be warranted in the subsequent reviews.

Impact on banks

In anticipation of the impact of the stiff hike in repo rate on loan growth, the RBI has revised downward the non-food bank credit growth projection from 19 per cent to 18 per cent for the current year.

The central bank has been more hawkish than the market had expected and some more action may be forthcoming from the RBI before the end of the next quarter review, which will exert more upward pressure on interest rates in the near future, driving bond yields higher from the present levels. The short-term money market rates and deposit rates are also expected to harden in the near term.

Considering the pressure on net interest margins already faced by banks, the base rates of the banks are expected to be increased immediately. The 10-year G-Sec Yield is expected to test 8.5 levels in the near future.

(The author is Chairman and Managing Director, Indian Overseas Bank.)

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