It has required as much skill and dexterity as in the case of a gymnast making a somersault in the air on a vaulting horse and landing on his feet without a jerk, earning 10 out of 10 points!

It has withdrawn the Special Refinance Facilities. In any case they were not utilised, thus making no difference to the situation. The Statutory Liquidity Ratio (SLR), which had earlier been lowered to 24 per cent from 25 per cent, is restored to its old level.

Now banks have a substantial surplus of securities on SLR account; so the rise by one percentage point will not strain their resources.

The immediate result of a few modifications in the policies relating to provisioning and CBLO transactions in the money market was a fall in the values of real-estate and banking shares. But what one has to see is the response in general.

In any case, the stock market is driven as much by what happens outside the country and the movement of capital as by domestic factors.

The knee-jerk reaction by way of the fall in Sensex by around 120 points soon after the announcement of the policy will wear off after some time. The markets will be back to their roller coaster ride.

The central bank needs a robust macroeconomic model, periodically tested and updated, that could form the basis for policy action in relation to the growth of Gross Domestic Product (GDP) and inflation.

Merely looking at a number of indices, as it seems to be doing a la Greenspan, is not enough. But then Greenspan, as also his successor, have had the results of a macro model also to work with.

Such a model for India, prepared by P.K. Pani, Adviser, was published by the Bank in the Reserve Bank of India Occasional Papers (circa 1983) with which this writer was associated.

One has not seen any further work in this area since then despite the abundance of talent available in the Department of Economic Analysis and Policy and the access to scholars outside through the instrumentality of the Development Research Group.

In the absence of such a model, all the predictions (not forecasts!) based on the expected growth rate of GDP may be mere guesswork or wishful thinking, They are just based on assumptions about the growth rates of agricultural, industrial and service sectors that are summed up by applying appropriate weights — a commonsense and not a technical exercise.

The Bank’s estimate of a GDP growth of 6.0 per cent with an upward bias varies from projections by others. The interface between various markets is very critical to policy making now, unlike a few decades ago. This reinforces the need for macro modelling.

The Bank has reduced the money supply forecast by one percentage point to 17 per cent. An earlier article by this author (“The Money Supply Conundrum”, Business Line dated October 21, 2009) argued that even an optimistic GDP growth of 6.5 per cent this year will not call for more than 14 per cent expansion in M3.

The higher growth of 17 per cent does not jell with the prediction of an inflation rate of 6.5 per cent, considering the damage to kharif crops.

Rice procurement operations so far are reported to be below their levels during the corresponding period of last year. Government has been saying for more than one year that because of the large official food stocks the country need not worry about shortages. But the price of rice has been going up relentlessly.

It is quite likely that wheat procurement may also suffer, irrespective of the production level, if farmers’ demand for higher prices is not conceded.

The rise in the prices of sugarcane and rice, approved by government, will be a source of encouragement for them. One may expect a near double-digit inflation by the end of March 2010. One suggestion that has been heard for raising the demand curve for gilts, thus reducing yields, is to increase the limit for holding securities in the “Held to Maturity” (HTM) category (25 per cent) in the portfolios of banks that does not call for mark-to-market valuation.

Now the excess of securities held by banks over the legal requirement for SLR is such that they do not have to buy any more bonds till March 2010 to meet their obligations, if deposits grow at the current rate.

So it is clearly a buyers’ market. The RBI has not conceded the demand for raising the ceiling on the HTM category.

The review says: “As the HTM ratio is already higher than the prescribed SLR, it is not considered desirable to further raise the HTM ratio.” (p 19) This is not correct in view of the rise in SLR to 25 per cent.

There is thus a case for raising the HTM ratio to 26 per cent to maintain the status quo ante of a difference of 1 per cent.

One may expect the yield on the 10-year bond to rise to 7.5-8 per cent, if not more, by January end when the government’s market borrowing programme is expected to be completed.

The Bank should refrain from resuming the buyback of securities to salvage the situation. It has turned out to be counter-productive and costly so far resulting in losses, which provide capital, not liquidity, to the market participants.

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