RBI abandons 'baby steps' to tackle inflation

From ‘baby steps’ to a significantly ‘large step’ was the Reserve Bank of India’s (RBI) answer to inflation. The rise in policy rates (repo rate) by 50 basis points to 7.25 per cent signalled aggression to tackle inflation, which the apex bank has projected at six per cent with an upward bias for March 2012.

Thus, there is a readiness to sacrifice growth to tame elevated inflation pressure, especially for the next two quarters.

RBI Governor D Subbarao, elaborating the stance of the Monetary Policy for 2011-12, said, “RBI will work to control demand to check inflation and navigate a soft landing for the economy.” That is, it wants to minimise harsh effects of factors like high commodity prices.

PROJECTIONS
Then and now	Finance minister	RBI governor
FY12 GDP growth (%)	9	8
Inflation	5	6
Fiscal deficit	4.6	Difficultto be met

The domestic demand-supply balance, the global trend in commodity prices, and the likely demand scenario will weigh on inflation, RBI said. Inflation is expected to remain at an elevated level in the first half of the year, before gradually moderating towards March 2012.

Spelling out the policy stance, RBI said there were three prime objectives. One, it is the apex bank’s endeavour to maintain an interest rate environment that moderates inflation and anchors inflation expectations. In March 2010, RBI shifted its focus from expansionary to a tighter monetary regime. This was the ninth interest rate rise since then, and the biggest one. The earlier eight increases were of 25 basis points each.

Two, the policy expects to foster an environment of price stability that is conducive to sustaining growth in the medium term, coupled with financial stability. Third, it will manage liquidity to ensure that it remains broadly in balance, with neither a large surplus diluting monetary transmission, nor a large deficit choking off fund flows.

Giving a rationale for giving preference to fighting inflation at the altar of growth, the RBI governor said over the long run, high inflation was inimical to sustained growth, as it harmed investment by creating uncertainty.

The current elevated rates of inflation pose significant risks to future growth. Bringing these down, therefore, even at the cost of some growth in the short run, should take precedence.

High oil and other commodity prices and the impact of the anti-inflationary monetary stance will moderate growth. The apex bank, in this growth and inflation calculation, has assumed a normal monsoon, and crude oil prices averaging $110 a barrel over the full year 2011-12.

RBI pegged the economic growth for 2011-12 at 8 per cent, lower that the estimated 8.6 per cent for the year gone by (2010-11).

The factor that shaped the outlook and monetary strategy for 2011-12 was that higher inflation may persist, and indeed get worse, since headline and core inflation have significantly overshot even the most pessimistic projections over the past few months. This raises concerns about inflation expectations becoming unhinged. On the positive side, the likely moderation in demand should help reduce pricing power and the extent of pass-through of commodity prices.

Source: Business Standard