Balancing act: check prices, back growth

CRR hike to support recovery process, says RBI.

The third quarter review of monetary policy was about ensuring price stability. And, it was articulated clearly, as the Reserve Bank of India (RBI) said it was worried over rise in food prices affecting other commodities and services.

While RBI’s policy action, an increase of 75 basis points in the cash reserve ratio (CRR), was aimed at containing inflation and managing inflationary expectations, Governor D Subbarao was candid enough to mention at a post-policy press conference that the central bank struggled with price-based and quantity-based variables but settled for a CRR hike, as it would anchor inflationary expectations without upsetting growth.

He said inflation largely stemmed from supply-side factors, though there were some demand pressures too. But the latter were largely incipient, he added.

The decision to suck out liquidity came in the backdrop of expectations of higher capital inflows, which could add to inflationary pressures. “Depending on how these (inflows) are handled, there will be implications in terms of a combination of exchange rate appreciation, larger systemic liquidity and the fiscal cost of sterilisation,” said the review.

RBI appeared less worried about economic growth, though it said the recovery was still uneven and public expenditure continued to play a dominant role. Despite this, the strong industrial growth in recent months and recovery in exports gave enough comfort to the central bank to revise the growth estimate for the current financial year from 6 per cent to 7.5 per cent.

Subbarao said by merely increasing CRR, RBI was trying to encourage investments to support the recovery process and contain inflationary pressures from the demand side.

RBI’s assessment was that despite Rs 36,000 crore being sucked out of the system on account of a higher CRR, there would be sufficient amount in the system to meet credit demand. It acknowledged lower demand by revising the credit growth estimate to 16 per cent, which is still higher than the 13.88 per cent reported for the financial year till January 15.

In contrast, the revised projections on deposit and money supply growth are in line with the levels seen this year.

With limited options as far as using imports to check food prices are concerned, signs of firming up of global commodity prices and the looming threat of increasing crude oil prices, the central bank raised the estimate for inflation based on the wholesale price index to 8 per cent at the end of March from 6.5 per cent projected three months ago.

In December, inflation was 7.3 per cent and, according to RBI’s assessment, it will start moderating only from July. But even that comes with a caveat: “This moderation in inflation will depend upon several factors, including the measures taken and to be taken by the Reserve Bank as part of the normalisation process.”

Subbarao said the monetary policy would continue to condition and contain the perception of inflation in the range of 4-4.5 per cent, with the medium-term target being 3 per cent.