This refers to your editorial, “The usual trade-offs” (January 18). Here’s a caveat. In the first place, the current inflation is not just a supply-side phenomenon. Elementary textbooks on Economics refer to demand and supply as two blades of a scissors, doing the cutting job of price determination. If we see inflation as a result of too much money chasing too few goods, certainly the unleashing of liquidity in the economy in the last one year has aggravated the problem of scarce supplies.
Secondly, the Reserve Bank of India’s (RBI) action of reducing rates, and thus bringing about quantitative expansion, was a panicky reaction to the Lehman episode. It merely aped the policies of the western central banks without recognising the qualitative differences in the situation. While the money and the capital markets froze in the west, it was not so here. Again, while the west faced the prospect of recession, for India, the problem was one of a reduction in the growth rate.
Thirdly, as a corollary of the previous statement, the problem was sectoral — affecting the country’s exports and not the entire economy. It called for sector-wise relief measures. They were undertaken and are bearing fruit now.
Fourthly, that the system did not need all the money released has been borne out amply by the return trip of the funds through reverse repos to RBI on a massive scale. RBI has unnecessarily released funds of around Rs 3,500 crore during the last year (with its own multiplier impact) by way of interest on the money parked.
And finally, RBI made the problem of excess funds worse by its buy-backs of government securities. It monetised the fiscal deficit, indirectly violating the spirit of the Fiscal Responsibility and Budget Management Act. The withdrawal of special refinance facilities, not availed of by the system, and the raising of the statutory liquidity ratio (SLR) by one percentage point, when the banks had large excess SLR investments, in October, did not really tighten the policy. It only validated the system’s response and was reactive. The least that RBI can do now to undo the damage is to raise the cash reserve ratio by one percentage point. It should also have the magnanimity to admit its error of judgement by using appropriate words instead of standing on a false sense of prestige.
A Seshan, on email
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