RBI monetary policy: The liquidity lever may prove to be better price tamer

economictimes.indiatimes.com:

Whenever monetary authorities wanted to influence price levels for goods and services, they resorted to the popular tool — interest rates that make money more expensive or affordable. If inflation climbs, they raise the interest rate to dampen demand, and if growth slows, they reduce the cost of funds to fuel demand. With inflation in India soaring due to high vegetable prices, the Reserve Bank of India, going by the textbook, could have raised interest rates. But it did not do so. It expects the current high prices for vegetables to be temporary. But Governor Shaktikanta Das promised to act when high prices turn out to be persistent. That means whenever the RBI moves next to put a lid on price pressure it would be an increase in the key repo rate, the rate at which it lends to banks. But there’s a slight twist that is emerging. “The recent spike in CPI inflation is expected to be short-lived going by past trends,” said Das. “In such situations, we need to remain watchful and not resort to any knee-jerk reactions. And deployment of policy instruments is not just in terms of rate and stance but there are other ways of dealing with it. We have done our bit with regard to the incremental CRR today.”

RBI asks banks to set aside incremental CRR

Governor Das is signalling that tinkering with liquidity could gain more prominence in monetary policy decisions than interest rates. Historically, monetary transmission has been the RBI’s nemesis. For long, the central bank was hooked on the belief that liquidity deficit alone made its rate actions effective. But years of practice showed it was not. Subsequently, it bought into a neutral liquidity policy. Monetary transmission is still haunting the central bank.