Steady approach

The Reserve Bank of India’s (RBI) decision to raise the repo rate, reverse repo rate and the cash reserve ratio (CRR) by 25 basis points can be termed as the apex bank’s slow, but steady approach to tackle the problem of inflation. In fact, many in the banking circles were expecting the RBI to take stronger measures considering the rapid increase in inflation rates. But the RBI’s twin moves — make money dearer and mop up liquidity (about Rs 12,500 crore will be sucked in by way of increased CRR) — is a clear signal that it will continue to pursue the anti-inflationary policy in a calibrated way. The fact that RBI Governor D Subbarao has not ruled out increases in CRR and in key rates in the future is a clear pointer that more monetary tightening will happen if the situation demands.
RBI’s steady approach is certainly the right policy prescription for the moment as it is aimed at maintaining a balance between price rise and growth. While containing inflation is important, the cost of money must not be pushed up so much that the industry and the business start to groan. Banks are already complaining that although the economic growth is expected to be higher, the credit off take in the first four months of 2010 has not improved much. Of course the slackness in the credit market and ample liquidity in the system are making things a bit easy for the borrowers.

Besides, there is no guarantee that RBI’s actions will have the desired effect in curbing the price rise which depends on many factors beyond the central bank’s control. Wholesale rate of inflation is ‘artificially suppressed’ in India because the government does not allow the prices of petroleum products and fertilisers to be revised in line with the increase in international prices. Curbing liquidity may not help much because the primary reason behind price rise is the shortage of food stuff. As the supplies of vegetables, fruits, pulses, cereals, edible oil, sugar — major contributors to food inflation — are far lower than demand, their prices will continue to remain high. Economic recovery has also made India a hot destination for foreign funds looking for higher return from here compared to near zero return in developed economies. This is also increasing money supply and putting pressure on prices. Clearly, tackling inflation effectively needs long term planning.