13 repo rate revisions in 19 months, yet no results

13 repo rate revisions in 19 months, yet no results

The prices of food and non-food items are rising steeply and moving up month after month with the latest inflation figure touching 11.43 per cent in the week ending October 15, from 9.72 per cent in September. The figure stood at sticky around nine per cent some 10 months ago.

A curb on escalating food prices is important not only because it impacts the aam aadmi but also because of the fear that a persisting high food inflation gets generalised and spreads to manufactured items, which constitute more than 65 per cent in the wholesale price index. But the prices are refusing to relent.

Inflationary pressure has largely emanated from increase in administered petroleum product prices, rise in minimum support prices of farm products and increasing cost of imported commodities due to depreciation in Indian rupee vis-à-vis the US Dollar.

Analysts say festering debt crisis in Europe and the possibility of another recession in the United States are also likely to impact the growth cycle back home with some impact on exports. The US and European Union together account for more than 30 per cent of India’s exports. As India has embarked on diversion of exports to other Asian countries and Africa since 2008, the impact of fall in exports to these countries will be somewhat cushioned.

As far as the banking system is concerned, the impact of the US and EU recession will  be less as Indian banks do not hold much of foreign debt and they will remain insulated. However, it is the foreign institutional investors who can potentially spoil the party as they sell their stocks and rush out of the market with Dollars.

Concerned over the state of affairs, Prime Minister Manmohan Singh, himself a well-known economist, recently held a meeting of top policymakers to find ways to tame escalating prices responsible for sluggishness in growth and an overall slowdown in  the economy. But all along he has been maintaining that slowdown is a global phenomenon and should not breed negativism among investors.

Finance Minister Pranab Mukherjee too sounded optimistic about the economic growth returning to 9 per cent in the medium term and inflation stabilising around 7 per cent by March 2012, notwithstanding the global slowdown.

But the basic question remains, why has inflation not moderated in the past as many months despite Reserve Bank of India’s repeated policy rate hikes-- latest on October 25 and 13th since March 2010.

Is the monetary policy not yielding desired results or the government has erred somewhere?    The RBI is trying to control money supply in the economy by raising repo rates, at which it lends to other banks, and reverse repo rates, at which it borrows from other banks. This has jacked up the interest rate in commercial banks.

However, the increase in the interest rate has done little to contain food inflation. On the other hand, high interest rates have sapped investors’ confidence and eroded medium term growth prospects.

A tight monetary policy has also slowed India’s industrial production considerably in the past few months, registering a sluggish 4.1 per cent growth in August, a tad higher than 3.8 per cent in July, its lowest in almost two years. The GDP growth also slowed to 7.7 per cent in April-June period, the weakest in six quarters.
Analysts and policy makers are of the view that current rise in prices has more to do with a demand-supply mismatch, which can only be addressed by the government rather than the RBI.    According to Prime Minister’s Economic Advisory Council’s Chairman C Rangarajan, the first task of the government should be to augment supply to check the demand-supply mismatch. He said “government’s fiscal policy has not been helpful in containing inflation”.

A senior economist from CRISIL, Sunil Sinha, said: “Currently there are no initiatives to augment the supply side and unless the fiscal side is also reined-in, there will be a demand-supply imbalance”.

True, there are structural concerns. The most important is to improve the supply chain, including functioning of government-regulated mandis that sometimes prevent retailers from integrating their enterprises with the farmers. The other measures could be cutting down on untargeted food and fuel subsidies. The recent fall in rupee, which breached Rs 50 a Dollar in the third week of October has further fanned fears of higher inflation and widened government’s subsidy bill. 

Although, the government and the RBI have projected that inflation will start tapering off in the next two months as the commodity prices have come off in the recent times, how far these projections will come true in the wake of global uncertainties and domestic problems, is anybody’s guess.

The commodity prices have come off in recent times but the impact of these has been offset by the fall in rupee following a flight of capital. Similarly, global crude remains firm despite a slowdown in western economies, exerting pressure on the fuel prices back home. In this scenario, it is hard to say which way inflation will move or should we brace ourselves for a double-digit inflation in times to come. 

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