Opinion - Editorials   

Anchoring inflation expectations

The RBI was widely expected to tighten its monetary policy in the wake of the latest spurt in inflation, which broke into double digits and touched 11.05 per cent recently. However its decision to use the statutory rate, the CRR, and the policy rate, the repo rate, simultaneously has come as a surprise. The CRR, which seeks to impound a slice of the deposits with banks, goes up by 0.50 percentage point to 8.75 per cent. The repo rate, the rate at which the RBI lends to ban ks against securities, will also increase by an identical margin to 8.5 per cent. Earlier this month, the RBI in increasing the repo rate by 0.25 percentage point underscored the recent monetary policy stance of responding to adverse circumstances as and when needed. The unexpectedly large inflation number of last week would have invited monetary intervention anyway. However, this time the trigger seems to have been pulled by the government. Having run out of policy options to influence the supply side, it virtually forced the RBI to assume a more aggressive role in combating inflation from the demand side — while conceding that demand side pressures have not been the main contributor to the problem. By freezing between Rs.19,000 crore and Rs.20,000 crore of bank deposits, the CRR hike will reduce the available lendable resources with banks. The repo rate has become the preferred policy signal to influence interest rates. Faced with a resource squeeze, banks will have no option but to heed the repo rate signal and increase their interest rates.

Monetary measures operate with a lag, at times as much as six to eight months. The RBI’s action is intended to anchor inflation expectations. As the high petroleum prices are unlikely to moderate even in the medium-term, it becomes the task of policy to facilitate adjustment to this new reality. Inflation expectations are guided by behaviour, not by statistics. Nearly all types of bank loans, especially the fast-growing home loan and retail loan segments, will become more expensive. The trade-off between growth and inflation has never been easy. The RBI might think it is intervening decisively in favour of price stability but economic growth concerns cannot be downplayed even in these difficult times. India’s central bank evidently reckons that containing inflation expectations is the key even if it involves pushing up interest costs. Economic growth this year might be lower than projected but inflation containment has become the top priority for economic policy, especially as the drumbeats of the 15th general election draw near.

Printer friendly page  
Send this article to Friends by E-Mail

Stories in this Section

Anchoring inflation expectations
Green buildings
Russia returns to Afghanistan, on request
A world without torture
Swedish approach to youth detention
Tolerance under attack
Jeevan, the casteless
Corrections and Clarifications
In god’s name
Pakistan-U.S. ties
Economic crisis
One-sided

Copyright © 2008, The Hindu. Republication or redissemination of the contents of this screen are expressly prohibited without the written consent of The Hindu