With the economy expected to register a healthy growth rate, it is not surprising that the focus of the Reserve Bank of India's first quarter review of credit policy should be on the worrying problem of inflation. WPI inflation has been in double digits since February. Although food price inflation and, more generally, consumer price inflation have shown some moderation, they are still in double digits. Non-food inflation has been rising rapidly and demand side pressures are mounting, leading to a more generalised inflation. Given that growth is firmly on track, “the balance of policy stance has to shift decisively to containing inflation and anchoring inflationary expectations.” In fact, since October 2009, the RBI's policy stance has been tilting towards price stability without ignoring the other traditional policy objective of meeting the credit needs of the real economy. Until the latest announcement, the reversal of the relatively easy money stance was marked by cumulative hikes in the CRR of one percentage point and the repo and the reverse repo rates by 0.75 percentage point each. The RBI has now hiked the repo rate by 0.25 percentage point to 5.75 per cent and the reverse repo rate by 0.50 percentage point to 4.50 per cent. The narrowing of the gap between the two repo rates is expected to introduce a measure of stability to the short-term interest rates. A higher reverse repo rate will also encourage banks to park their surplus funds with the RBI when there is a surfeit of liquidity.

The RBI expects a number of factors to play a part in dousing inflation, which it projects to drop to 6 per cent by March, 2011. These include satisfactory monsoons, a good kharif harvest and softening global oil prices. Its growth forecast for the current year has been raised to 8.5 per cent from the 8 per cent (with an upward bias) it had predicted in April. According to the Bank, the main risk factors would emanate from abroad. If global recovery falters, the performance of India and other emerging economies is likely to be adversely affected. An even greater risk lies in a possible slowdown in capital inflows, which have become quite critical to India's balance of payments. On the other hand, with central banks in the developed countries persisting with accommodative monetary policy, the country could face the problem of plenty, with flows increasing substantially, straining monetary and exchange rate management. In a welcome move aimed at improving the frequency and content of its communication to the markets, the RBI will now also undertake four mid-quarter reviews, making for eight in a year.

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