Comment: Jahangir Aziz, India Chief Economist, JP Morgan

One step forward, two steps backwards

This is what Tuesday’s RBI’s policy review said: Curbing inflation was the central bank’s dominant policy concern. Despite better harvests, food inflation has been stubbornly high, as demand has consistently (in RBI’s language “structurally”) outstripped supply.

Importantly, it saw non-food manufacturing inflation as being persistently above trend. Presumably, this has little to do with supply shocks and everything to do with demand pressures.

Ominously, RBI warned of the possibility of the economy hard-landing, as the combination of high fiscal deficit, current account deficit and inflation could turn away investors, decelerating growth.

And, this is what the RBI did: It raised policy rates by just 25 basis points! Even if one doesn’t agree with any of its views (I do, except for the part about the current account deficit becoming unsustainable), the yawning inconsistency between its economic outlook and actions must come at least as a surprise. Perhaps, part of the reluctance to move more aggressively is explained by its frequent lament that it cannot do much to fix the structural problems. True. One also sympathises with RBI’s exasperation with the government’s expansionary fiscal stance.

 

All that said, RBI remains the keeper of the country’s macroeconomic stability. If the government isn’t playing ball by implementing reforms or cutting back the runaway stimulus, it just means that RBI needs to over-compensate. And it can.