RBI Governor Reddy on the share market

In its April monetary policy, Reserve Bank of India Governor Y V Reddy surprised the market by not hiking the interest rates. Two months later, in June, he raised its policy rates hours after the European Central Bank hiked its key rate by a quarter percentage point to a three-year high of 2.75 per cent.

The central banks in Thailand, Korea, Turkey and South Africa also hiked their key rates around the same time, while the Bank of Canada and the Reserve Bank of Australia raised their key rates between late April and early May.

The RBI move, once again, surprised and shocked the market since there was no apparent reason for such a hike with the inflation rate being well within the RBI target. In fact, there were instances earlier when there were concerns on the domestic front but the Indian central bank refrained from any rate hike.

For instance, in August 2003, WPI inflation shot up to 8.7 per cent. Despite this, the RBI preferred to wait till its mid-year review of the monetary policy in October to hike the reverse repo rate - the rate at which the RBI sucks out excess liquidity from the financial system - by a quarter percentage point to 4.75 per cent.

By that time, the inflation rate had dropped to about 7 per cent. In September 2005 too, when the government hiked oil prices, the RBI did not act and waited till its mid-year review of the monetary policy in October to raise the reverse repo rate by a quarter percentage point to 5.25 per cent. It showed no urgency to combat the rising inflationary expectations in the aftermath of the oil price hike.

These instances point to a critical shift in the RBI's monetary policy stance: In its scheme of things, the external developments now have a larger say than the events on the domestic turf.

In fact, while announcing the April monetary policy, Reddy had said: "In a situation of generalised tightening of monetary policy, India cannot afford to stay out of step. It is necessary, therefore, to [not only] keep in view the dominance of domestic factors as in the past, but [also] to assign more weight to global factors than before, while formulating the policy stance."

If he sticks to this stance, one can expect maintenance of status quo when the central bank announces its mid-year review of the monetary policy next week.

This is because the US policy rate has peaked and some of the members of the Federal Open Market Committee, the policy-making body of the US Federal Reserve, have started talking about reduction in rates to pep up the economy, which has been showing signs of a slowdown.

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