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RBI: Growth slowdown not commensurate with inflation control

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The Reserve Bank of India (RBI) has said in the tussle between growth and inflation, the former has not been commensurate with the latter.

“Interest rate is a blunt instrument. It first slows growth and then inflation. But the has not been commensurate with inflation control,” said Deepak Mohanty, RBI’s executive director in a speech at a function yesterday. According to him, raised its policy 13 times between March 2010 and October 2011 by a cumulative 375 basis points. The policy repo rate rose from a low of 4.75 per cent to 8.5 per cent. Still, it did not help contain inflation.

The Wholesale Price Index (WPI) inflation for December fell to 7.18 per cent from 7.24 per cent in November. This gave RBI the comfort to cut the repo rate by 25 basis points to 7.75 per cent in the third-quarter review of the monetary policy last month. RBI also revised downwards the baseline projection for March 2013 to 6.8 per cent from 7.5 per cent earlier.

Mohanty said in order to bring inflation down on an enduring basis and anchor inflation expectations there is a need for policy action on several fronts. He added it was important to aim for nutritional security not only to harness the demographic dividend stemming from our sizeable young population but also to contain food prices. He said, “This will require addressing the supply-demand imbalance in the agricultural sector and modernising the supply chain.”

There is also a need for concerted efforts to secure energy security for the country.

He said, “The bulk of our fossil fuel requirement is met by imports. A necessary step in this direction is market-related pricing of petroleum products to economise consumption and reduce the subsidy burden. This should be supplemented by a step up in electricity generation so as to minimise the fall back option of diesel generation of power.”

According to Mohanty, in a supply constrained economy, potential output is not a reliable gauge for inflation threshold as firms operate below capacity and yet retain the pricing power. Hence, reliability of power supply and availability of necessary industrial raw materials are important for industrial capacity utilisation and improvement in productivity. “Besides moderating inflation, this will also reduce reliance on imports of products for which domestic capacity exists,” he said.

Mohanty is also of the view that it is imperative to maintain exchange rate stability to cushion transmission of international price pressures in commodities, particularly crude oil.

He said, “This will require management of the current account in our balance of payments with the rest of the world at sustainable levels.”

Mohanty said fiscal consolidation is important for maintaining both domestic and external balance so that we avoid the risks of twin deficits. “As our own high growth experience of 2003-08 suggests, lower fiscal deficit not only encourages private investment but also helps in maintaining price stability,” he opined.

He said while persevering with the steps to increase the depth of the financial market and addressing credit constraints, monetary policy needs to be calibrated to the evolving growth-inflation dynamics so that we move towards our potential growth in a non-inflationary manner. “For a country at our stage of development with a vast labour supply, potential growth is not a constant. Only in an environment of price stability, a step up in investment accompanied by productivity improvements could bolster potential growth,” said Mohanty.

According to him, even when the supply side factors dominate the inflationary pressures, given the risks of spillover into a wider inflationary process, there is need for policy response. “While monetary policy action addresses the risk of unhinging of inflation expectations, attending to the structural supply constraints becomes important to ensure that these do not become a binding constraint in the long-run, making the task of inflation management more difficult. By ensuring a low and stable inflation, RBI could best contribute to social welfare,” he added.

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