Growth casualty of RBI's efforts to combat inflation in 2011

The RBI's steely resolve to combat inflation by repeatedly hiking key interest rates despite opposition from industry and other quarters yielded results toward the end of 2011, with food inflation slipping below 1 per cent and general inflation showing signs of moderation.

Thanks to the initiative taken by the central bank during the year, inflation would cease to be a major concern in the New Year, though the government and RBI will have to deal with slowing economic and industrial growth.

The RBI raised the repo rate, at which commercial banks borrow funds from the Reserve Bank, seven times during the year, by 2.25 percentage points to 8.5 per cent.

However, it was a different matter that the efforts of RBI Governor D Subbarao to tame inflation did not soften inflation in the immediate run and instead pulled down the economic growth rate and industrial production.

Another issue that troubled the RBI was the declining value of the rupee against the US dollar.

The Governor reiterated the stated policy of non- intervention in forex markets to correct currency imbalances and looked the other way as the rupee fell to historic lows.
The same set of challenges will remain for the Governor in the new year in the back drop of moderating growth, weakening  macro-economic fundamentals and a declining rupee.
However, going forward, if one were to go by the tone of the last monetary policy statement on December 16, it seems that Subbarao in the new year will focus on promoting growth, which has become the biggest casualty of his tight monetary stance in 2011.

In order to tame inflation, Subbarao opted to take only baby steps, ignoring the advice that he should "go for the kill".

Though food inflation declined from 16-17 per cent in January to less than 1 per cent in December, headline inflation remained near the double digit mark. Moderation was, however, witnessed toward the close of 2011 and there is a good possibility of it declining further in the new year.

Improvement in the price situation will make the RBI more receptive to the advice of India Inc. The central bank will definitely contemplate reducing interest rates at its next policy review due on January 24.

Till the second quarter review (when he raised the repo rate by 25 basis points to 8.50 per cent), Subbarao maintained a hawkish stance, saying, "Low growth is better than high inflation and that unless growth decelerates to below trend (a word he often used during the year to reflect 8-plus per cent growth), there will not be any change in the monetary stance." With inflation under control, Subbarao, who got a two-year extension one month before his first term came to an end, will have to focus on arresting the fall in growth and the decline in the value of the rupee.

During the course of the year, RBI was criticised for being directionless and its failure to come out with out-of- the-box solutions.

The worst remarks came from Chief Economic Advisor Kaushik Basu, who described Subbarao's monetary policy stance as "text-bookish" and devoid of any forward-looking stance.

For RBI, however, there was little option but to continue the tight money policy initiated in March 2010, to contain inflation.

From January through October, Subbarao raised interest rates seven times to 8.50 per cent, even at the cost of ignoring the advise of the technical advisory committee. A dovish stance, however, did manifest in December.

Significantly, RBI left both the bank rate (cash reserve ratio) and statutory liquidity ratio unchanged at 6 per cent and 24 per cent, respectively.

Today, the bank's effective lending rate varies from 12 per cent to 18 per cent, with the rates for unsecured loans even touching 20 per cent in the cases of some lenders, indicating effective monetary transmission.

As regards inflation, it declined to 9.11 per cent in November after it had crossed 10 per cent in September. It was 9.78 per cent in October.

The saving grace, however, is the food price index, which slipped to a six-year low of 0.42 per cent for the week ended December 17 from 15.48 per cent a year ago.
The inflation problem was aggravated by rising crude and commodity prices on one hand and increasing government borrowings and a widening deficit on the other. The falling rupee, too, added to the worries of the government.

Growth, unfortunately, became the biggest casualty during the year.
While factory output barely managed to remain in the green zone in September, it nosedived to minus 5.1 per cent in October. Last week, the Governor admitted that the GDP will not clip above 7.6 per cent this fiscal.

According to government data, economic growth in the first quarter of the current fiscal (April-June 2011-12) slowed to 7.7 per cent. It further slipped to 6.9 per cent in the second quarter.

Despite the many challenges on the monetary management front, the RBI did not lose sight of the common man.

In fact, 2011 was one of best years for retail banking customers as the RBI unveiled a slew of radical reforms by forcing bankers to give customers more by way of higher interest rates on savings deposits.