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Another round of tightening

In its latest credit policy, the Reserve Bank of India has brought monetary policy instruments to bear heavily on the priority area of inflation. Notwithstanding the recent signs of a slowdown and even at the risk of moderating growth further, it has in its first quarter review hiked the repo rate and the CRR by 0.50 and 0.25 percentage points respectively. As recently as in the last week of June, the RBI raised both by 0.50 percentage point. The repo rate, now at its high est level since 1999, has emerged as the most decisive policy signal for higher interest rates. The CRR hike clearly shows that, in the central bank’s assessment, liquidity is still a major cause for concern. Although there are some early signs of moderation in money supply and deposit growth, they continue to expand beyond the target. Non-food credit has risen by nearly 26 per cent on a year-on-year basis up to the first week of June 2008, as against 24.6 per cent a year ago. Clearly, aggregate demand pressures in the domestic economy continue to be strong, exacerbated by the weak supply response. The recent hike in domestic fuel prices has aggravated inflationary pressures but even at the revised levels they do not fully reflect international crude prices. Prices of many other key commodities have risen in the global markets, exerting significant pressures on the domestic economy. The upshot has been a sharp increase in inflation which is ruling just below 12 per cent. Not only is the WPI inflation well above the monetary policy’s target range of 5-5.5 per cent for the year, it shows no signs of moderating.

The overriding policy objective therefore is to bring down inflation ideally to below 5 per cent, but more realistically to a level close to 7 per cent by March 31, 2009. The GDP growth projection for the year has been revised downward to 8 per cent from a range of 8-8.5 per cent, but other forecasts are lower still. Inflation is a global phenomenon. However its pernicious influences are felt more in the emerging economies than in the developed ones. The International Monetary Fund and other institutions have called upon their central banks to tackle it on a priority basis. The continuing turmoil in the global financial markets has created unprecedented uncertainty, making the RBI’s task particularly onerous. The trade off between growth and inflation abatement has always posed difficult choices for policy makers. For quite some time now, the RBI has been emphasising inflation containment over growth. The latest review leaves no one in doubt as to what its priorities are.

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