Caught between the compulsions of its own dharma, of fighting inflationary expectations and keeping inflation low, and the sentiments of the markets, corporates and policymakers in New Delhi, the Reserve Bank of India has opted for the middle path, eschewing the bravado of a pause but shying away from stiffer action. In continuing with its 25 basis points ‘baby step’ hike, while assuring the market that it may then pause for at least a quarter, governor Duvvuri Subbarao has fired what would seem to be his last bullet. If even this action does not subdue inflationary expectations, he would either be forced to use heavy weaponry or be more candid in drawing attention to all the factors beyond a central bank’s control that seem to be driving inflation and slowing growth. The RBI’s statement on Tuesday lists them as follows: structural imbalances in agriculture, infrastructure capacity bottlenecks, distorted administered prices of several key commodities and the pace of fiscal consolidation. Dr Subbarao has bravely stated that the risk of inflation on account of these factors “can only be mitigated by concerted policy actions on several fronts. In the absence of progress on these, over the medium term, the monetary policy stance will have to take into account the risk of inflation surging in response to even a moderate growth recovery.”
But, the moot point is what more can RBI do to fight inflation without hurting growth? If New Delhi joins forces and delivers better policy performance on other fronts, the promised pause could last longer. But, and this is the question, if Delhi does not deliver, will the central bank have the courage to shift gear and move from ‘baby steps’ to more energetic strides? The tone of the governor’s statement suggests that his spirit is willing, though the body politic may be weak.
The decision to announce a mid-quarter pause would appear to be the RBI’s way of liberating itself from its own self-imposed six-week policy review cycle. Perhaps this is why the governor chose to go in for a 25 bps hike, despite the central bank’s own stated concerns about growth and slowing down of investment. Better to take a step forward now, and pause for a quarter than pause now and lend mid-quarter reviews greater weight than required. More so because the policy statement lists several ‘risk factors’ over which the central bank has virtually no control.
If any of these factors push prices up, it is not clear whether a further hike in interest rates would automatically dampen inflation without hurting investment and growth, and thereby employment. It is noteworthy that few macroeconomic policy statements in India as yet examine the impact of policy on employment, and yet it would seem that monetary and fiscal policy have now reached the point where action or inaction can impact employment prospects, especially in urban areas. Hence, any anti-inflationary strategy going forward cannot remain impervious to growth and employment prospects. Having said that low inflation is good for growth, RBI is now saying going too far and too fast in reducing inflation may be bad for growth. That is the key message coming out of the central bank’s review and statement this week.