Inflation much above threshold: Subbarao

The Reserve Bank of India (RBI), which has maintained a tight monetary stance to combat inflation, said domestic inflation remained much above its tolerance levels. Governor D Subbarao defended the monetary tightening done by the central bank in this scenario.

“Estimates by the Reserve Bank using different methodologies put the threshold level of inflation in the range of four-six per cent. With the wholesale price index-based inflation ruling above nine per cent, we are way past the threshold,” Subbarao said. At this high level, inflation was unambiguously ‘inimical to growth’, the governor added.

The regulator said high inflation hit medium-term growth prospects and investor confidence. Hence, monetary tightening was crucial even if near-term growth prospects were reduced. “Reserve Bank’s monetary tightening is accordingly geared towards safeguarding medium-term growth, even if it means some sacrifice in near-term growth,” Subbarao said.

There may be a shift in the stance of the central bank, if the economic growth rate falls significantly below the trend rate, he said while clarifying that the country’s trend growth rate, after the financial crisis of 2008, was eight per cent.

“With our trend growth rate, post-crisis, estimated at eight per cent, the balance of policy stance would shift if growth fell consistently and substantially below that rate. But a shift in stance will also be a function of the behaviour of the external and internal drivers of inflation,” he said.

The central bank has increased the repo rate by 350 basis points in the last one-and-a-half years to fight inflation. The monetary tightening has been criticised by the industry chambers, as it has led to moderation in growth. While the index for industrial production stood at 3.3 per cent annually for July this year, much lower than 8.8 per cent in June, the inflationary pressures refused to cool off. The benchmark wholesale price inflation rose 9.7 per cent in August from a year earlier, compared with a 9.22 per cent increase in July. The central bank told its critics that monetary tightening would play an important role in tackling inflation by curtailing demand, as the high prices were a result of both supply- and demand-side pressures.

Our monetary policy stance is guided by this understanding and is aimed at restraining demand and anchoring inflation expectations, Subbarao said while speaking at a business school in New York recently.

“The argument of our critics that monetary policy has no role because inflation is a result of imported commodity prices would have been valid if the increase in commodity prices was a pure and transient supply shock or if there were no demand pressures,” he further said.

While the governor said RBI’s strategy would depend upon the direction of the inflation trajectory, it would not let the growth rate to fall beyond a level. “Simultaneously, we also noted that the stance of monetary policy will be to manage the risk of growth falling significantly below trend,” Subbarao said.