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Inflation fears and tighter money

The mid-term review of the annual credit policy sticks to the format of the annual statement of April and the quarterly review of July. Predictably there are few surprises. Increasingly, the policy statements now presented once in three months have been looked at more for the Reserve Bank of India's authoritative views on the economy and the financial regulatory system, and much less for the monetary measures. A widely anticipated 0.25 percentage point increase in the reverse repo rate has been announced and it is the only liquidity reducing measure. Simultaneously the repo rate too has gone up by an identical margin. Neither the bank rate nor the cash reserve ratio (CRR) has been touched. The former, a structural rate that used to be the benchmark for the cost of credit, seems to have gone out of fashion even as the horizon for monetary interventions has shifted to the short-term. As for the CRR, its efficacy is questionable during times such as the present, when liquidity is so abundant that a small hike in the reserve ratios will have no impact. Besides, the RBI is committed to doing away with many types of statutory pre-emption as part of financial sector reform. In line with the practices of many leading central banks, monetary management by the RBI has come to focus on short-term instruments such as the repo rates. The liquidity adjustment facility (LAF) that has been operated with great success allows the RBI to calibrate money supply within a narrow range and over very short periods. The reverse repo rate, the rate at which the RBI borrows from the market, sets the floor while the repo rate, the rate at which it lends, constitutes the ceiling. With the hike at both ends, the central bank has clearly signalled a tighter monetary policy.

Inflation is a bigger worry than it was even three months ago. Of the several global uncertainties that could impede growth in India, the RBI has once again focussed on the high oil prices, which are now seen to have a "large permanent component". Oil importing countries will have to factor in the second round effects of oil prices. That calls for greater vigilance on the price front in India. The large increase in export earnings of oil producers has not only aggravated the serious imbalance between savings and investment at the global level but has also given a push to the exponential rise in liquidity with a potential to stoke up inflation. The interest rate cycle has definitely turned. Since September, eight central banks have marked up their rates. The U.S. Federal Reserve has hiked the interest rates 11 times in a row. Within India, prices of assets, notably housing and shares, have been inflated. The Bank has increased its GDP forecast for this year to between 7 and 7.5 per cent from its earlier 7 per cent. However, as before, the generally optimistic outlook is tempered by the realisation that in the current climate of uncertainties, both global and domestic, any sudden development can dampen growth.

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