'Use short-term rates to beat inflation'

The Raghuram Rajan panel has suggested a change in Reserve Bank of India's (RBI) strategy in managing inflation.

While recommending a minimal intervention in the foreign exchange market, the committee on financial sector reforms, in its draft report, has proposed that the central bank should focus on keeping inflation low or within a range.

The committee said the RBI should only use short-term interest rates "" repo or reverse repo "" to inject or suck out liquidity and manage inflation. It should cut the interest rates if inflation falls below the objective rate and raise the rates if price rise is beyond the central bank's comfort zone.

Pointing to benefits of this strategy, the panel said it can best serve the cause of inclusion because the poorer sections are least hedged against inflation.

There are other benefits in choosing this option. An exchange rate that reflects fundamentals does not tend to move sharply and serves the cause of stability.

It will also limit the burden on the budget following a reduction in the accumulated foreign reserves beyond what is necessary for precautionary purposes.

Lastly, exporters who are weaned away from expecting an undervalued exchange rate will focus on increasing productivity, thereby contributing to growth.

The panel has argued against imposing control on foreign capital flows. Sterilised currency intervention by the central bank can re-export inflows, but it is rarely effective beyond the short term and creates other costs for the economy.