The day the Reserve Bank of India (RBI) raised the repo and reverse repo rates by 25 basis points, taking them back to just last March’s pre-election level, the Indian Meteorological Department announced that this year’s monsoon is likely to be normal. The message from the moneymakers, the rainmakers and the macroeconomic authorities is clear — yesterday’s “skewflation” will not be allowed to become tomorrow’s generalised inflation. The central bank may have surprised all with the timing of its announcement, but the better informed would not have been surprised by the direction of policy. Even though senior RBI officials told the media after the January 28 policy statement was issued that the central bank would not raise rates till its next policy statement in April, the central bank’s own statement did not give that assurance. Rather, as we had pointed out editorially, RBI had explicitly warned that it would raise rates, if necessary, and even before the April policy statement. The monetary policy statement of January 28 categorically stated that the central bank’s policy would be to “anchor inflation expectations and keep a vigil on the trends in inflation and be prepared to respond swiftly and effectively through policy adjustments as warranted”. RBI Governor D Subbarao had also very clearly signalled the end of an accommodative monetary policy stance by stating that the central bank was shifting from “managing the crisis” to “managing the recovery”.
The January 28 statement also explicitly recognised that while current inflation pressures stem from the supply side, the recovery increases the risk of these pressures spilling over “into a wider inflation process”. The implication was that if the recovery process sustains and demand-driven inflation pressures build up, RBI would not hesitate to hike policy rates. It would be useful to recall that the January 28 statement also said, “However, on the assumption of a normal monsoon and global oil prices remaining around the current level, it is expected that inflation will moderate from July 2010. This moderation in inflation will depend on several factors, including the measures taken and to be taken by the Reserve Bank as a part of the normalisation process.”
All in all, the central bank has acted predictably, even if it chose earlier to mislead the market by suggesting that no action would be taken till April. It is now clear as crystal that reversing inflationary expectations is the number one policy priority of the government. The choice for policy-makers was stark — 9 to 10 per cent growth with double-digit inflation or 7 to 8 per cent growth with single-digit inflation, hopefully less than 7 to 8 per cent. The growthwallahs would have erred on the inflation front, the stabilitywallahs would prefer to err on the growth front. A little less growth for a little less inflation is better than much more growth with much more inflation. Having sent the correct signals out both on the fiscal policy side and on monetary policy, and having joined the battle against inflationary expectations, the government must now act on the reform and legislative side and ensure that the growth momentum is sustained. For their part, banks and financial institutions must step in and walk the talk on financial inclusion and keep the wheels of commerce well-oiled.
