Tripping Growth – TANEESHA KULSHRESTHA

Is RBI Governor D Subbarao waging a futile battle against inflation?

On July 26, RBI hiked repo and reverse repo rates by 50 basis points, the 11th such hike since March last year. The move rattled a market expecting a 25 basis points hike. It also conveyed RBI’s tough stance on controlling inflation even at the cost of growth. Inflation stood at 9.44% for June and has continuously remained above the 8%-mark for the past 18 months, a rate higher than RBI’s comfort zone of 4-4.5%. Clearly, the rate hikes have not worked till now. Meanwhile, growth is already suffering. For instance, India’s factory output grew at just 6.3% in April as compared to 13.1% last year. This scenario is expected to worsen. “We are only at the early stages of seeing the impact of the monetary tightening, the negative effects of which are likely to persist well into 2012-13,” said a Credit Suisse note in June. This begs the question: has RBI Governor D Subbarao indeed lost his touch? Through successive rate hikes, RBI is trying to reduce the money supply in the system and bring down effective demand. Unfortunately for RBI, the rising prices are a combination of domestic and global market phenomena beyond its control. Commodities like coal and oil have been witnessing continuously high prices fuelled by uncertain political dynamics in West Asia and the growing demand from emerging economies. Closer home, inherent supply side constraints continue to fire inflation. Agricultural productivity has stagnated while policies regulating food retail and distribution need urgent reform. “The retail margin charged between the farmer and the end consumer is too high,” says DK Joshi, Chief Economist, Crisil. Recent fuel price hikes for diesel and petrol too have added to inflationary pressures. Clearly, focusing on monetary policy alone will not give the desired results. “Some blame government schemes, like MGNREGS and other such rural employment schemes, for increasing demand pressures, but that is not correct. What we need is reforms and policies that encourage agriculture and manufacturing,” says independent economist Anjan Roy. RBI, too, agrees. “The Reserve Bank’s efforts of achieving low and stable inflation could also be supported by concerted policy actions and resource allocations to address domestic supply bottlenecks, particularly in respect of food and infrastructure,” said Subbarao in a statement. In a not so subtle warning against profligacy he added, “Fiscal consolidation can contribute to a sustainable growth path by rebalancing demand away from government consumption and towards investment.” For now, rate hikes are expected to continue. The RBI is clearly at war.

The Outlook