By restricting its major policy action to a 25 basis point hike in the repo rate, the Reserve Bank of India has accomplished two things. One, it has shown that it continues to believe that the economy is growing at somewhat above sustainable rates, thereby risking the acceleration of inflation in the future. This is consistent with its position over the last nine quarters. To the extent that its reactions to key macro-economic indicators are becoming more predictable, they are becoming less disruptive. This may not make for good headlines, but it contributes to stability. We can be reasonably sure that if growth and inflation point in the same direction three months from now, there will be a similar response in April. Two, it has also signalled that it recognises its own limitations as far as controlling inflation is concerned. Given that a significant contributor to the current inflationary spurt is food prices, monetary instruments are relatively ineffective in dealing with it. What is needed are quick increases in the supply of the items concerned. Whether this is forthcoming or not, it is certainly outside the powers of the RBI to provide. What it has reacted to in choosing to hike the repo by the conventional 25 basis points are the sustained increases in the prices of manufactured goods, which are more reflective of demand pull inflation and which it can address with some hope of effectiveness. | |
| In the event, the fears about a sledgehammer monetary policy have proved to be baseless. Many people thought that a 50 basis point hike in the repo rate was on the cards, possibly accompanied by further escalations in the cash reserve ratio (CRR), an instrument that the Reserve Bank of India (RBI) had dusted off and used in December. The main reason for the expectation that the RBI would become heavy-handed in its quarterly review was that both growth and inflation have been quite far above the stated "comfort zone" of the RBI""8 per cent and 5-5.5 per cent, respectively. The early indicators of third-quarter growth, whether in the form of the November numbers on industrial production or in the extremely positive corporate results that are still coming in, point to acceleration of the growth momentum of the first half of the year, which clocked slightly above 9 per cent. Inflation has already gone above 6 per cent in at least one recent week, and remains near that level. The RBI governor has justified his light touch on the monetary lever by arguing that he has no wish to choke off growth. It is not an easy balancing act that he has to perform. |
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| But while recognising the appropriateness of the RBI's action in the given circumstances, no one should forget the provocation for the CRR hike in December. The main reason for that was that foreign capital inflow was large enough to provide a significant infusion of liquidity into the banking system, making banks less dependent on the repo window to meet their reserve requirements. With Wednesday's announcement by the rating agency Standard & Poor's, upgrading India's sovereign rating from speculative to investment grade, a new potential channel of investment funds into the country has opened up. It is early to tell how significant this will be, but another flood of liquidity in the current quarter should not be ruled out, perhaps leading to additional use of blunt instruments before the next scheduled announcement, in April. |
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