Making the trade-off between supporting growth and reining in inflation expectations, a perennial dilemma of monetary policy, was particularly pronounced as the Reserve Bank of India unveiled its second quarterly review. The central bank’s action in keeping its policy rates — the repo and the reverse repo rates as well its key reserve ratio, the CRR — unchanged is above all a reflection of that intense dilemma. Economic growth, though picking up, is still far from robust. Professional forecasters surveyed by the RBI had lowered their GDP forecast for 2009-10 to 6 per cent from 6.5 per cent, estimated three months ago. The RBI too has not changed its July forecast of 6 per cent with an upward bias. That was more pessimistic than some other recent official forecasts. For instance, the Prime Minister’s Economic Advisory Council had projected a rate of 6.5 per cent just a few days ago. The RBI notes certain trends that are not so positive. Agriculture is expected to register a decline due to poor monsoons. While the industrial sector has shown clear signs of revival in recent months, the two major demand components of the GDP — private final consumption expenditure and gross fixed capital formation — have continued to decelerate, following a trend that began last year. Despite abundant liquidity in the system, non-food credit has dropped significantly, with its growth rate falling to 11.2 per cent from 29.4 per cent recorded last year.
The RBI expects headline inflation to climb to 6.5 per cent by the end of the year. This is sharply higher than the five per cent it forecast three months ago. Food inflation is a big challenge to policy makers. The consumer price index (CPI) remains stubbornly in double digits. Moreover, the base effect that artificially depressed the headline inflation figures will soon start working in the opposite direction. The precise challenge for the RBI is to support the recovery process without compromising on price stability. A related challenge is to manage the exit strategy from easy money. Pointing out that India is among the few large emerging economies with such large fiscal and current account deficits, the RBI has once again urged fiscal consolidation. The exit debate here will have to be quantitatively and qualitatively different from that in many other countries because of the unique macroeconomic features. Growth drivers warrant a delayed exit, while inflation concerns call for an early exit. The RBI has already taken some steps towards the exit: it has tightened bank provisioning norms and made lending to commercial real estate more expensive. More than ever before, monetary policy will have to strike a deft balance among several conflicting objectives.
