In its forthcoming review of the annual monetary and credit policy, the Reserve Bank of India will once again try to balance the often conflicting objectives of accelerating growth and reining in inflation. That traditional policy dilemma has become particularly acute today. To a large extent, the RBI’s quandary mirrors the current public debate on exit packages. Both the government and the RBI have indicated their preference for exiting from the stimulus packages but they are yet to spell out the time, nature, and extent of withdrawal. An exit strategy for the RBI would involve a reversal of its “super accommodative” stance that was formulated at the height of the global financial crisis in September 2008. Besides other measures, it pumped in a record Rs.600,000 crore of liquidity in a short span of time through reductions in reserve requirements and refinance facilities. The benchmark short-term repo and reverse repo rates were lowered by as much as 4.5 per cent. Like the other central banks, the RBI too resorted to unconventional measures such as quantitative easing for shoring up liquidity to forestall what appeared to be a major global recession. That threat has since receded.

However, as in many other countries, inflation has resurfaced in India, partly due to the surfeit of liquidity in the system. The Wholesale Price Index for December at 7.31 per cent exceeded the RBI’s target for the whole year. More worrying is the stubbornly high food inflation. The RBI and the government seem to be of the view that monetary policy measures will have little effect in a situation where increased food prices are brought about predominantly by supply side factors. However, the high prices of food and other essential articles will reinforce inflationary expectations. Economic growth in the country has picked up momentum and there is a distinct probability of the growth rate climbing to 8 per cent next year. While growth at this level suggests an interest rate hike, a number of other factors point to the maintenance of the status quo. For instance, the credit off-take has been low despite the benign interest rate environment. It is quite likely that the RBI will mop up liquidity through a hike in reserve requirements, leaving the interest rates unchanged. The RBI has already signalled a retreat from its easy monetary policy. An immediate monetary tightening, though directed at inflation, will mark the beginning of the retreat.

Corrections and Clarifications

A sentence in the first paragraph of "Tough choices" (Editorial, January 23, 2010) was "The benchmark short-term repo and reverse repo rates were lowered by as much as 4.5 per cent." Current repo and reverse repo rates are 4.75 per cent and 3.25 per cent respectively.