RBI raises the price of money — but only just

If the latest fine-tuning exercise of the credit policy by the Reserve Bank of India (RBI) evokes a sense of déjà vu, it is because the economic backdrop to it remains basically unchanged — an economy on the bounce-back syndrome and a price situation that remains explosive with the inflation rate still at elevated levels.

The task was thus cut out — to deploy the monetary weapons in such a way as to strengthen the growth

impulses without letting inflation play further havoc. As was expected, it has chosen to retain the cash reserve ratio at 6% while opting to hike the repo and reverse repo rates by 25 basis points each to 6.25% and 5.25%, respectively.

Some hardening of interest rates across the spectrum may ensue but this has probably been factored in by industry and the markets. While hinting that the status quo may prevail in the near-term in regard to short-term rates, RBI governor Duvvuri Subbarao has expressed optimism that the inflation rate may moderate to 5.5% by March 2010 — an improvement from the earlier indicative target of 6%. The real GDP projection is unchanged at 8.5%.

The governor appears to be more upbeat on the emerging trends in inflation than in the macroeconomic policy statement that accompanied the credit policy. In the latter, the RBI noted that the downward rigidity in
inflation has persisted despite a normal monsoon and the range-bound movement in international crude prices.

Despite this, Subbrao has maintained the long-term goal of reducing inflation to 3%, possibly to keep expectations anchored. The reality is that headline

inflation is high and food prices have not shown the
expected post-monsoon moderation. The policy statement warns of the structural nature of food inflation and its impact on inflationary expectations, its spillover to other commodities and the possibility of a reversal of the recent moderating tendency. The pressure is now from both ends — supply and demand.

One can infer, therefore, that while the RBI can act to quell the price fever, the role of the Centre to boost

supplies is no less important. Elsewhere in the policy enunciation, the central bank is very forthright when it says that monetary policy is more effective when there is fiscal equilibrium.

Global cues and supply rigidities also pose problems in the crafting of monetary policies but in the final analysis, it is the growth-inflation outlook that will shape the contours of the central bank’s response. The latest steps are apposite when seen in context.