Any vehicle that has one person’s leg on the accelerator and another’s on the brake can only move in jumps and starts. That is probably what is beginning to happen, with New Delhi’s leg on the spending accelerator and RBI’s leg on the monetary brake. The burden of the January 25 policy statement is that RBI is telling North Block to go easy on the accelerator, if it has to resist slamming the brakes. The debate on whether RBI should have increased policy rates by 50 basis points, given its stated concerns about inflation, or the 25 basis points it chose to misses the entire thrust of the central bank’s third quarter review and monetary policy statement. Make no mistake, the central bank is concerned about resurgent inflationary pressures. It should be expected to stay the course and raise rates further in its forthcoming reviews or even in mid-course. It has raised baseline projection of headline inflation rate, based on wholesale price index, by 150 basis points, from 5.5 per cent to 7 per cent, and has drawn attention to a range of factors, domestic and global, that would keep inflation rates above acceptable levels in the medium term. If the central bank has resisted more drastic action, opting to keep its powder dry, it would seem the reasons have to do with RBI’s views on non-monetary sources of inflation and its willingness to go along with other macro-economic authorities on the strategy for growth.
By keeping its powder dry, RBI has, however, reserved the right to strike a few weeks later, depending on how the Union government manages its fiscal balances. The combined risks from higher inflation, higher current account deficit (CAD) and “the fiscal situation”, as RBI puts it, “contribute to an increase in uncertainty about economic stability that consumers and investors will have to deal with. To the extent that this deters consumption and investment decisions, growth may be impacted. While slower growth may contribute to some dampening of inflation and a narrowing of the CAD, it can also have significant impact on capital inflows, asset prices and fiscal consolidation, thereby aggravating some of the risks that have already been identified”. New Delhi must get the message loud and clear. The ball is firmly in the finance minister’s court.
While the central bank sees no risk to growth, which it expects to be around 8.5 per cent in 2010-11, it recognises the emerging external constraints to growth and inflation management, especially the role of rising commodity prices, though the recent recovery in Indian exports growth is a hopeful sign that the higher-than-expected CAD can be managed. RBI believes that food, energy and commodity prices are widely expected to harden during 2011, “driven by a combination of supply constraints and rising global demand”, making inflation “a global concern in 2011”. In the light of both external and domestic trends, the Union government must pursue a responsible fiscal strategy that allows the government to keep control on fiscal and revenue deficits and sustains non-inflationary growth, by easing a range of supply constraints through policy reform and encouragement of increased investment.