Monetary Policy and US Subprime Crisis

By: EconomyWatch   Date: 30 June 2010

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Abstract:
There is a general expectation that the US Subprime Crisis is going to influence the upcoming monetary policy review of the Reserve Bank of India. Some are expecting that a cut in interest rate is going to take place, while some think Reserve Bank will hold the interest rate at the same level at least in this review period, although an interim cut can take place in future.

Monetary Policy and US Subprime Crisis can bear connection. But, it will be evident only after the announcement of Monetary Policy by the Reserve Bank of India(RBI).

Last month that is in December 2007, RBI governor Y. V. Reddy opined that cut in interest rate by US Federal Reserve will not determine the nature of Indian monetary policy. But, on 21st January, expressing his worries he said that the US Subprime Crisis has created disturbance in the world financial markets in a scale which is much greater than the expectation. He revealed that the next monetary policy will be formulated by RBI keeping in mind this problem of US Economy Recession.

According to the Reserve Bank Governor, the global uncertainties arising out of US Subprime Market Crisis were anticipated on a preliminary basis. But, the extent and intensity of the problem was not rightly speculated.

Speculation that Reserve Bank is going to introduce a interest rate cut in its next monetary policy review has generated another speculation about US Interest Rates. Some of the experts are anticipating that a cut in interest rate in India will lead to another interest rate reduction in US.

The speculation about interest rate cut by RBI originated from the incidence of reduction in Indian bond yields. As the stock market suffered, the yield of the Indian bonds decreased to a level which was the lowest in a year.

Further there are speculations that the Fed Reserve can cut interest rates by 50 basis points. If the speculation comes true, then this interest rate cut by Fed can result in major capital inflow to India. This capital inflow can result in further appreciation of Indian Currency.

A low rate of inflation has the ability to resist a interest rate cut. But, attaining low level of inflation is also not possible at present. This is because, the Indian govt. is thinking over raising the retail fuel prices and high oil prices will raise the level of inflation.

It can be mentioned here, that RBI increased its' short term lending rate five times between June 2006 and March 2007. But, for the last ten months , it has maintained the short term lending rate at 7.75%.


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