Managing inflation, growth dynamics amid uncertainties

Policy raises rates to check inflation, while promising sufficient liquidity for growth.

“It is a post-recovery period for us. But for the world, as a whole, it is still a recovery period,” said Reserve Bank of India Governor D Subbarao.

RBI’s main worry: Managing the growth-inflation dynamics, as both demand and supply-side factors are at play.

The central bank expressed confidence that economic growth was steadily re-aligning with the pre-crisis trajectory and domestic growth drivers would help absorb global uncertainties.

Consequently, the pause button has been pressed on an immediate rate rise, barring any shocks. But inflation, along with demand-side pressures and expectations, needs to be contained and anchored. Deputy Governor Subir Gokarn said the stance was to manage growth and inflation dynamics in a still uncertain global environment.

“The policy takes care of the growth needs of the economy and addresses legitimate inflationary pressures,” said S Raman, chairman and managing director of Canara Bank.

A liquidity deficit mode for the past few months is consistent with an anti-inflation stance. But the central bank is also conscious that any excess deficiency may hurt growth.

“Excessive deficiency can be disruptive to both financial markets and credit growth in the banking system. To ensure economic activity is not disrupted by liquidity constraints, the liquidity deficit needs to be contained within a reasonable limit,” RBI said.

Friday’s reminder
Last Friday, the deficiency touched an all-time high, when the net borrowing by banks through the liquidity adjustment facility amounted to Rs 117,000 crore. This prompted the announcement of some liquidity easing measures, albeit temporarily, such as opening a second liquidity adjustment facility window and one per cent leeway on the statutory liquidity ratio.

The monetary policy stance is intended to ensure that liquidity remains broadly in balance, with neither a surplus diluting monetary transmission nor a deficit choking fund flows.

O P Bhatt, chairman, State Bank of India, said, “Inflation has declined but not gone down enough to provide comfort. The rate of decline is much less than expected. On the other hand, economic growth in India is reasonably good and broad-based. In this context, RBI had two choices – one, not to do anything, or to do something that gives the right signal to the market. So, they have raised rates to give the correct signal.”

The central bank has retained its growth and inflation forecast for the current financial year. RBI projects inflation at 5.5 per cent (in the new series) by March 2011 and gross domestic product growth at 8.5 per cent.