RBI MEANS BUSINESS

The monetary policy action of the Reserve Bank of India on Tuesday is being billed as a negative surprise in some quarters, a picture of stiff action that went beyond what the market in its conventional wisdom expected and even a hardening of policy stance that, it is being said, will ` kill’ growth. The collective noise built in the run up to the policy was that the RBI would hike its key policy rates at the most by 25 basis points, and reach a maximum further tightening of 50 basis points by the end of the year. After all, hasn’t the RBI already given us ten rate hikes since March last year, and, it was being asked, how much can it tighten further? The RBI’s answer has been quite different, even uncharacteristic. What the market expected to be doled out through the full calendar year in doses of 25 basis points has been dished out in one stroke. So the repo rate and the reserve repo rate have both been moved up 50 basis points in the first quarter review of monetary policy for 2011- 12 announced by Governor Dr. D Subbarao. This is a heavy hammer which the central bank now wants to make clear will be used with force to fight inflation. In fact, the RBI action comes not a day too soon. The headline WPI inflation rate for the first quarter of this fiscal was close to double digits; its level and persistence has surprised many in the establishment. Non- food manufactured product inflation, which is essentially demand driven, has been at seven per cent and higher since April 2011 as against four per cent during the last six years. So as the RBI itself has pointed out, inflation continues to be the dominant macroeconomic concern. What the RBI did not say explicitly is that inflation stays put at the forefront despite the series of steps that have raised rates slowly but surely. Those baby steps, as they have come to be called, of 25 basis points at a time have yielded little. The RBI did raise the repo rate by 50 basis points in May 2011 which was a salutary measure; it then went back to the small increase of 25 basis points in June 2011. Now, this is the second time RBI has come in with a 50 basis points hike. Questions are bound to be asked on whether the RBI should have moved faster in its earlier rounds of tightening to achieve its goal of controlling inflation and anchoring inflationary expectations. If it had, there are those who will argue that its goals would have been reached earlier, easier and with probably lesser action. Given the poor monetary transmission process in India, the 25 basis point variations are ineffective. As a senior central banker like S S Tarapore, who has handled monetary policy for three decades has pointed out in this context, the old Bank of England dictum used to be ` up by ones and down by halves.’ There is a useful message in this particularly for India, where the government, industry and banks are all against strong monetary policy measures, and the case now has become presented as one of growth versus inflation as if growth can be sustained if inflation is not in check. Given the noise and aspirations that were raised this time of little or no action, the RBI deserves to be commended for not succumbing and standing up for a bold measure that maybe unpopular among important or influential sections but is very appropriate in the larger interests of the nation. As it is, the country is facing turbulent times. The UPA government has been reeling under a series of scams and there is no telling what will come next and who it will take down. The government has been accused of a policy paralysis just at a time when the economic environment is uncertain. The government must also soon prepare for State elections in key states like Uttar Pradesh and the Punjab. It can ill afford to live with the alarming levels of inflation that have been ruling our country for long now. In that sense, the RBI action should also fit into the urgent priorities of the government. The question that many are asking is now a simple one: will the RBI pause from here on, or are we likely to see the hammer being wielded again and again. The RBI policy has a pointer: ` A change in stance will be motivated by signs of a sustainable downturn in inflation.’ It will be good if the RBI sticks to that goal and delivers a ` sustainable downturn’ in inflation.

FPJ