The monetary policy announcement by Governor Dr. D. Subbarao on July 26, 2011 is one of the most forthright Statements coming out of the Reserve Bank of India ( RBI). The merit is that it has a central agenda, namely inflation control, which, after all, should be the main focus of RBI's monetary policy. Global and domestic factors point to the continuation of strong inflationary pressures. On the global front there is the problem of the Euro debt and the threat of a country default in the United States. Even if a compromise is hammered out in Congress by August 2, 2011, it would be a temporary patchwork and the issue of the US debt would continue to loom large and have global fallouts. International crude oil prices continue to remain high and earlier hopes of a significant reduction in crude oil prices have been belied. With overall growth in the industrial countries being sluggish and loose monetary policy continuing over a prolonged period, a strong resurgence in inflation is likely. In India, the growth rate in 2010- 11 was satisfactory at 8.5 per cent ( revised numbers will show a higher growth rate). Although some slowdown in the rate of growth is inevitable, projections point to the continuation of growth in 2011- 12 of 8 per cent. The inflation rate in India, on a year- onyear basis, was expected to fall, but at the end of June 2011, the inflation rate was 9.4 per cent; the revised number will be higher and a double digit inflation rate appears inevitable. Authoritative estimates are that inflation will first worsen before it starts to decelerate. Earlier it was felt, in official circles, that inflation would come down on its own but if at all it has worsened. As compared with the RBI's comfort zone of a 4.0- 4.5 per cent inflation rate, the projection in May 2011 for March 2012 was 6 per cent. To the embarrassment of the RBI, in July 2011, it had to raise this projection to 7 per cent. Even if the inflation rate is contained at the end of March 2012 at 7 per cent it would be a mere statistical illusion, as from a high base the subsequent period would reflect a deceleration What is relevant to the Common Person is that the level of prices continues to rise. With some uncertainty regarding the final outcome of the monsoon, there are pressure points. Kharif sowings for pulses, coarse gains, oilseeds and cotton have been distinctly lower than last year Again, prices of protein rich items remain elevated. There is also a considerable element of " suppressed" inflation which is reflected in under- recoveries of subsidized fuel which is estimated at Rs one lakh crore. Whether the administered prices are raised or the subsidies are borne by the government, this would add to inflationary pressures. Till recently, it was argued that the inflationary pressures were transitory; it is now clear that inflation is strongly embedded in the manufacturing sector and the longer the authorities wait to contain inflation, the more difficult will be the task. The merit of the RBI's July 26, 2011 policy is that the RBI has trained its eye exclusively on the issue of tackling inflation. While vested interests large industry, banks, financial institutions and financial markets urged the RBI not to raise policy interest rates any further, responsible media and economists recognized the need for stronger monetary policy action. The response to the increase in the repo rate, ( the rate at which RBI provides accommodation to banks against government securities), from 7.5 per cent to 8.0 was that the measure was " shocking", that it was utter " madness" and that the economy would go into a tailspin. Of course, the stock market tanked on news of the measure and there was instantaneous adverse response. This knee- jerk response is bound to cool off as market participants recognize that the measure, though necessary to tackle inflation, is not disruptive to the production process. To attain the objective of first bringing down inflation to 7.0 per cent and subsequently down to the RBI comfort zone of 4.0- 4.5 per cent would require a lot more measures. The RBI would need to persevere with 0.50 per cent increases in the policy rate at the time of its mid- term review on September 16, 2011 as also the full review on October 25, 2011. The very thought of considering these measures would trigger apoplexy among vested interests and they would lobby effectively to thwart such measures. The RBI must be steadfast in its resolve and not yield to such pressures. It is disconcerting that some top policymakers nonchalantly talk of a new higher ' normal' of a 7 per cent inflation rate as against the well established ' normal' of 4.0- 4.5 per cent. The RBI should take the opportunity to clearly specify that it does not reckon the so called new ' normal'. It is better for the RBI to take appropriate measures now and take the punishment from market participants, rather than be condemned later for inaction. The present repo rate of 8.0 per cent is too low relative to deposit and lending rates. The RBI is treated as the lender of first resort and not the lender of last resort as it should be. To be effective, the RBI policy rate has to be a penal rate. A disappointing feature of the July 26, 2011 policy was the total absence of baby steps towards deregulation of the Savings Bank Rate. The RBI could fix this rate as a range, say 4.0- 5.0 per cent. The State Bank of India Chairman, though against deregulation, has suggested that the present 4.0 per cent fixed rate could be raised. As a preemptive measure the SBI has fixed its term deposit rate for 7 days at 7 per cent with a waiver of penalty for early withdrawal. Savings Bank depositors should move a substantial part of their Savings Bank deposits to 7 days term deposits with banks which offer 7 per cent or thereabout. Banks cannot be complacent that the inertia of loyalty will ensure that their Savings Bank accounts will not move. A deposit rate war is imminent and the RBI should forthwith move in a decisive manner.
FPJ
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