Policy first defence against inflation: RBI

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Price rise largely driven by supply-side factors and monetary policy has limited impact

Reserve Bank of India (RBI) Governor D Subbarao today reiterated that monetary policy remained the first line of defence against rising inflation even as much of the pressure had been from the supply side.

He said inflation had largely been driven by supply-side factors and monetary policy had limited impact.

“However, RBI has to do something,” he said in an interaction with students. “Policy becomes the first line of defence. If inflation persists for a long period, people think it is going to (remain) high. It becomes like a self-fulfiling prophecy.”

However, when asked if RBI would resort to inter-policy rate action, Subbarao refrained from any comment.

“I have said what I had to. I can’t comment on whether I will take inter-policy action,” Subbarao said.

RBI’s mid-quarter review is scheduled on March 17. Since November, it has been reviewing its policy every six weeks. Mid-quarter reviews were started to formalise any inter-policy rate action.

Earlier this week, the governor said RBI reserved the right to change its policy stance any time, the scheduled mid-quarter and quarterly reviews notwithstanding.

With the rise in incomes, the demand for protein-rich food had increased, driving up the prices of such articles, Subbarao said.

He said both structural demand and transient factors such as an uneven monsoon had driven prices up.

Food price inflation for the week-ended February 12 was 11.5 per cent, up from 11.05 per cent a week before. Headline inflation, based on the wholesale price index, has remained above eight per cent and was 8.2 per cent in January, as against 8.4 per cent in December.

RBI had already taken steps to tame inflationary expectations, he said. “To break that inflationary expectation psyche, RBI had to act, which is why we have been acting over the last one year,” he said. The central bank has raised policy rates seven times since March to curb inflation and inflationary expectations.

When asked about volatility in capital flows and the RBI’s response, Subbarao said the country needed to be predictable on its policy over flows.

Although market participants expected RBI to intervene when the currency was appreciating, the central bank has to take cognisance of the impact on importers and, therefore, on government subsidies, he added.

Earlier this week, the governor had reiterated that RBI intervened in the foreign exchange market to curb volatility and any impact on liquidity was incidental.

On the growing concerns over the functioning of microfinance companies and the resultant report by the committee set up under the chairmanship of Y H Malegam, Subbarao said RBI was examining the report.

The government and the central bank would come up with a better framework for the sector in the next two months, Subbarao said.

The Malegam report has recommended a cap on interest rates charged by the microfinance companies and the amount of loans sanctioned by them to individuals.