The RBI’s latest policy move is clearly influenced by growing threats of inflation and inflationary expectations to India’s macroeconomic stability. Its decision to keep the policy rates and CRR unchanged amid deteriorating growth outlook looks vindicated, given that the news about the May 2012 CPI inflation, which came a tad later on Monday, read 10.36 per cent. The country’s retail inflation last month rose on the back of sharp price spikes from vegetables, edible oils, milk products, energy products, clothing and footwear segments. True, international crude prices have fallen during the previous month, but the rupee depreciation has offset its impact on the wholesale prices.
Clearly, RBI is concerned about the stagflationary phase, where slumping GDP is accompanied with very high retail inflation. According to monetary experts, the key to preventing stagflation is to avoid allowing too much money to enter the economy too quickly.
Moreover, RBI had, in April, frontloaded the policy rate reduction, with a cut of 50 bps that had seen a broad-based transmission. In its assessment, interest rate reduction at the current juncture will add more to inflation than to growth, given that the present slowdown is driven by structural impediments.
At the same time, RBI’s policy has come out with relevant sector-specific measures. As Indian exports have slowed significantly, RBI has increased the limit of export credit finance from 15 per cent to 50 per cent of outstanding export credit to augment liquidity and to encourage banks to increase credit flow to the export sector. This, in its assessment, would potentially release additional liquidity of over Rs 300 billion, equivalent to about 50 bps reduction in the CRR.
All in all, the RBI’s cautious approach in Monday’s policy reflects its delicate handling of the inflation-growth dynamics in a stagflationary phase.
M D Mallya
CMD, Bank of Baroda