On 27th October the Reserve Bank of India released one more of its routine quarterly reviews of monetary policy. On reading the text, an interested observer would consider this a non-event. The central bank has done virtually nothing in terms of policy change. Interest rates such as repo rates at which the RBI lends to the banking sector which had been reduced in the wake of the global crisis have been left untouched. And the cash reserve ratio that impounds a part of the banks' deposits, which too had been reduced, has not been hiked. The only change even worth noting was the decision to restore the Statutory liquidity Ratio (SLR) (or the ratio of investments by banks in specified—largely government—securities relative to their net demand and time liabilities) to its earlier 25 per cent level, from the 24 per cent to which it had been reduced as part of the monetary easing resorted to in the wake of the crisis. This could in principle pre-empt a part of the banks' resources, but is without any import because excess liquidity with the banks had already encouraged them to invest in SLR securities, with such investments amounting to 27.6 per cent of their net demand and time liabilities on October 9, 2009.

Besides this, other changes are principally reductions in enhanced refinance facilities for export credit provided by banks and the discontinuation of a couple of special refinance facilities aimed at increasing liquidity in the banking system. Put simply, not much has been done, especially given the RBI's own assessment that ''the banking system has been awash with liquidity since November 2008'', so that ''the utilisation of the several refinance facilities instituted by the Reserve Bank'' has been low.

Despite the absence of anything new in this edition of a routine quarterly exercise, it attracted much attention in the financial press. Moreover, the major stock markets and stock price indices sank on the day of and after the announcement, and analysts attributed the dampened sentiment to the monetary policy review. Clearly, for the financial sector at least, monetary policy today is far more important than it was in the past. So much so that a review near-bereft of new substance is significant enough to elicit a sharp response. There could be two reasons for the latter. One could be that the financial sector expected some ''positive'' initiatives which did not materialise. The other could be that it gleaned from the review signs of developments that it would consider adverse. In fact, it possibly was a bit of both.

The importance of monetary policy clearly derives from its role in determining the availability and cost of credit. In earlier times this mattered only because of the influence this had on productive investment. So long as the inducement to invest existed, the availability of reasonably priced credit facilitated such investment. However, with the onset of financial liberalisation credit gained in importance because of its enhanced role in two other areas. First, it supported credit-financed housing investments, automobile purchases and consumption of various kinds. Hence, easy and cheap credit spurred demand, served as a stimulus to economic activity, contributed to better profit performance and imparted a degree of buoyancy to financial markets. Second, with liberalisation increasing the number and types of financial agents, all of whom are less regulated, credit and leverage played a role in driving activity in financial markets, including activity of a largely speculative nature.

Monetary policy has also gained in importance because an abiding feature of the consecutive waves of ''economic reform'' in the age of active finance, is growing fiscal conservatism. Governments now accept in principle, even if not always in practice, that a proactive fiscal policy incorporating significant deficit-financed spending needs to be abjured. They see such intervention as being potentially inflationary and disruptive of financial markets. In the view of finance, therefore, macroeconomic management should rely more on monetary policies devised by a central bank that should be made independent of government.

One consequence of this privileging of monetary policy relative to fiscal policy was that even when the global crisis, precipitated by a speculative, mismanaged and poorly regulated financial sector, forced governments to accept the need for a ''fiscal stimulus'', most stimulus packages included efforts to pump liquidity into the system and keep interest rates low Such packages have served finance well, since they not only benefited real economy actors but the financial sector as well. In fact, the scenario today in most developed countries is one in which the financial sector which was near collapse is faring better than the real economy, and within the financial sector, those entities which are focused on making and managing financial 'investments' are faring better than those that are dependent on the revival of credit demand from the real economy (such as the typical commercial bank).

What the remarkable responses in post-reform India to monetary policy pronouncements, including the most recent quarterly review, suggest is that this country too has seen post-reform changes that give monetary policy and its consequences an important role in economic management. In fact, there is reason to believe that the role of monetary policy would increase substantially in the immediate future. The reason for this is that a combination of the outlays necessitated by the Sixth Pay Commission's recommendations and the moderate fiscal stimulus resorted to in the wake of the slowdown in growth induced by the global crisis have substantially increased the government's deficit-financed spending. The budget for 2009-10 had projected the fiscal and revenue deficits for the year at 6.8 and 4.8 per cent respectively, and figures for the first 5 months of the financial year (April-August) indicate that 46 and 55 per cent respectively of the projected deficits have already been incurred. This increases the pressure on a fiscally conservative government bound by its own Fiscal Responsibility and Budget Management Act to prune these deficits. Put otherwise, the fiscal stimulus is likely to get weaker rather than stronger in the future, since there is little additional headroom available on the fiscal front. The reliance on monetary policy is, therefore, bound to increase.

In fact, the reliance on the monetary lever has already been substantial in recent months. Between October 2008 and October 2009, the RBI has reduced the repo rate by 425 basis points from 9.00 per cent to 4.75 per cent, the reverse repo rate by 275 basis points from 6 per cent to 3.25 per cent and the cash reserve ratio by 400 basis points from 9 per cent to 5 per cent. In sum, the central bank has already extended itself significantly to increase the volume of liquidity and reduce interest rates.

The financial sector has benefited from the monetary largesse of governments, both foreign and domestic. The massive infusion of liquidity into the economies of the developed countries by their governments has substantially increased the access of foreign institutional investors (FII) to cheap finance, which they have been leveraging to invest in their own equity markets and in those of emerging markets like India. The net result has been a remarkable rally in India's stock markets. That FII-induced rally has, in turn, encouraged domestic entities to access the cheap liquidity infused by the RBI to invest in equity and exploit the stock market boom, driving stock prices even higher. Nothing illustrates this more than the fact that even banks have leveraged the excess liquidity in the system to make substantial investments (of around Rs.92,000 crore during the months till October in the current financial year) in units of mutual funds. What banks cannot do as regulated financial intermediaries, they seem to be doing by finding proxy investors for themselves.

However, the response to the recent monetary policy review indicates that all this is not good enough for financial players. The problem is that there is growing realisation that markets have overshot the real economy by a substantial margin, with price earnings ratios touching uncomfortable levels. If the boom in the stock market is not to unwind a more robust recovery of the real economy is necessary. The RBI's growth projections do not provide grounds for optimism on this front. Credit off take by the private sector is low, and the growth in scheduled commercial banks' non-food credit at 4.3 per cent is significantly lower than the growth of 10.5 per cent in the corresponding period of last year. And the private banks have reined in retail lending which supports demand, because of the risk accumulated by their already high exposure to the retail sector. In fact, foreign banks have reduced their aggregate exposure to the retail sector. This deprives the system of an important stimulus for recent growth.

Given all this perhaps the markets were looking for a concerted effort on the part of the RBI to push credit, cut interest rates, stimulate demand and the real economy and provide the foundations for the recent rally in stock markets. Instead what they have got is an expression of concern that the government's fiscal deficit is far too high and a declaration that the stage has been reached where, given the excess liquidity in the system, a strategy to exit from the easy money policy adopted in response to the global crisis must be formulated and implemented. A reduce fiscal stimulus and monetary tightening if combined would have seriously adverse consequences.

Even though the quarterly review could do or actually did little to advance these tentative objectives outlined by the central bank, the fact that it did not do anything to the contrary may have frightened markets. However much they may rail against the State and its intervention, these markets need either the Finance Ministry or the Reserve Bank of India to support and increase their profits. If these agencies even just hold back, disappointment is intense and the results are intriguing.