The RBI’s Monetary Policy for 2013-14 is one of cautious optimism. While the optimism comes from turnaround in all the macro parameters, caution is driven by the limited macroeconomic improvement and embedded risks that still remain in the system.

In this context, as widely expected, the central bank delivered a 25 bps cut in the policy Repo Rate from 7.50 per cent to 7.25 per cent, which will help boost sentiment.

Inflation, growth and liquidity are the most important drivers and all these have been addressed in the annual policy. At 6 per cent in March 2013, headline WPI inflation is the lowest in the last six years.

Core inflation has also been steadily trending down on the back of easing input prices and shrinking pricing power of corporates, so the RBI’s inflation projection of 5.5 per cent by March 2014 appears to be realistic.

But we need to remain vigilant on the inflation front as retail inflation remains high, fuel inflation is in double digits and food inflation could flare up in the face of deficient monsoons.

The Repo Rate cut signals that monetary policy will remain supportive of Government’s efforts to revive growth. However, with GDP expected to grow by 5 per cent in FY13 and only 6 per cent (down from 6.5 per cent) in FY14, recovery will at best be shallow. At the same time, the current account deficit at 4-4.5 per cent remains well above the sustainable level of 2.5 per cent so the policy space to cut rates remains limited.

On the regulatory front, the increase in risk weights and provisioning requirements of banks for unhedged forex exposures is a step in the right direction.

Low interest rates and investment grade rating have allowed corporates to increasingly access the international capital markets for funds.

But a large portion of these borrowings remains unhedged — according to some estimates, this is as high as 60-70 per cent — thus aggravating foreign exchange risk.

In the past, the RBI has asked banks to ensure that corporates hedge their foreign currency borrowing. But this will only increase the cost of borrowing so corporates could move away and banks could lose business.

It would perhaps be more realistic for the RBI as the regulator to insist that corporates hedge their borrowings when the limits come up for renewal.

Another positive development is the restriction on loans against the security of gold coins as well as the decision to restrict the import of gold by banks only to meet the genuine needs of exporters of gold jewellery, which will help to curb the demand for gold.

Overall, a balanced policy that has tempered optimism with prudence and caution.

(The author is an Independent Business Economist and former Chief Economist, State Bank of India.)

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