Underlying inflationary pressures have accentuated, warns the Reserve Bank of India (RBI) in its mid-quarter review of monetary policy, adding that ‘risks to growth’ are also emerging. These concerns, the RBI explains, justify its decision to hike the repo and the reverse repo rates, under the liquidity adjustment facility (LAF), by 25 basis points, from 6.5 per cent to 6.75 per cent and from 5.5 per cent to 5.75 per cent, respectively. Would the RBI have been compelled to take this action this week if there was no mid-quarter review? Or, would this action have been superfluous if the central bank had, in fact, raised rates by 50 basis points at the time of its last quarterly review, instead of the 25 basis points hike? Economists and market analysts will debate that issue as much as whether the RBI’s monetary policy actions will make any difference at all to the price level when a variety of non-monetary factors are also responsible for driving up prices. The merits and demerits of big bang rate changes versus baby steps will continue to divide analysts. However, the RBI has let it be known that it is still, indeed even more so, worried about inflation and will not take its eye off the price radar merely because growth is likely to be hurt.
The central bank has signaled several concerns: the threat of rising oil prices globally and the need for upward adjustment of domestic energy prices; incipient demand-side pressures as represented by rising non-food manufacturing inflation; doubts about the ability of government to get a grip on subsidies and contain the fiscal deficit within budgetary estimates; and, ability of the agricultural sector to ease supply-side pressures on the price front. Given all these concerns, the central bank has opted for caution and placed inflation management at the centre of its policy. If this means some dent on growth, so be it. The RBI is right to assert that fiscal consolidation remains a key priority in inflation management and inducement of higher growth. It is critical, says RBI, “to focus on the quality of expenditure, keeping the aggregate under control without compromising on the delivery of services. Only by doing this can the fiscal situation contribute to demand-side inflation management.”
On the external side, the RBI has conceded that its earlier alarmist view of a widening current account deficit may have been exaggerated and that the more recent “robust” performance of exports means that CAD can be contained at 2.5 per cent of GDP, a view already expressed by the prime minister’s economic advisory council. The RBI’s reiteration of the importance of bringing in “long-term” capital flows, especially foreign direct investment, “so as to enhance the sustainability of the balance of payments (BoP) over the medium-term” is a reminder to a government that has been lackadaisical in handling the challenge of attracting more FDI into the country. Taken together — its views on inflation, the current account deficit and capital flows — it seems the RBI does not see itself facing the impossible trinity at this time. The focus of monetary policy is the rate of inflation.