Inflation fears

The Reserve Bank of India’s decision last Friday to increase the repo rate and the reverse repo rate — rates at which the central bank lends to banks and borrows from them — was not expected at the time the decision was made. Both rates were raised by 25 basis points.
The RBI’s credit policy review is due for July 27 and a rate hike was expected only then. But by acting three weeks ahead of that, the central bank has made it clear that inflation is a major concern for it, warranting urgent action. While food inflation is showing signs of easing, the overall inflationary pressure is still strong. The RBI has indicated that it expects about one per cent increase in wholesale price index as a result of the increase in prices of petroleum products. It has also factored in the impact on prices of the freeing of diesel prices likely to be effected by the government in the near future.

The easing of food inflation may be temporary and deceptive. It happened only in relation to a high base. There is still some uncertainty about the monsoon in some parts of the country and if it is below expectations, food prices will start spiralling again. Much of the wholesale price inflation in May was accounted for by non-food manufacturing and commodity prices.
So it is prudent not to lose sight of the price scenario. Though a major part of food inflation may be attributed to supply-side constraints, monetary tools, may go only as far they can in dealing with the situation. The global economic outlook is also not stable and reassuring. The finance ministry may not have been in favour of a policy rate hike at this juncture but the central bank perhaps decided that there is no need to take a risk.

The increase in rates has not impacted the markets adversely, especially because banks have announced that they will not affect the lending rates in the short term. There is no possibility of credit crunch, which may slacken growth at a critical period. The RBI has ensured that banks will have enough liquidity at their disposal. Availability of resources can keep lending rates in check. While these are steps which need to be taken, the best defence against inflation remains increased production in all sectors of the economy.