Price stability and growth

The most recent anti-inflationary package of the Reserve Bank of India announced at the fag end of the financial year, comprising a 0.25 percentage point hike in the repo rate and a 0.50 percentage point markup in the CRR was not unexpected. For three weeks in a row, wholesale price inflation has been around 6.5 per cent despite the concerted efforts of the government and the RBI to arrest the trend. The monetary policy's target range for inflation is between 5 and 5.5 per cent. Since December 2006, the RBI has put up its policy rates thrice. Interestingly, along with its earlier preference for adjusting repo rates, the RBI has recently been relying on the CRR too to achieve monetary targets. A hike in CRR drains liquidity almost immediately and is therefore a blunter instrument having a wide-ranging impact. Evidently in the central bank's view the time has come to deploy all its monetary weapons to combat inflation. In the wake of the RBI package, bank loans to the fast-growing home and consumer market will become more expensive. While the large corporates might still manage to get loans at below prime rates and more frequently seek funds from abroad, it is the small and medium enterprises that will bear the brunt of the rate hikes. The profitability of the corporate sector as a whole could be hit. But while the bumper profits of the last few years may not be sustained, they might still be in a position to earn enough to please the stock markets. At any rate, the expectation is that the costlier bank loans would not be a deterrent to many of their expansion plans.

The larger message is that while the principal policy objectives continue to be economic growth and price stability, the emphasis has shifted decisively to the latter. Inflation above the RBI's threshold limit is unacceptable. Monetary tightening has in fact been going on since September 2004. Along with the hikes in policy rates the RBI has made certain types of bank loans more expensive. Yet bank credit has continued to grow annually at 30 per cent and more. During 2006-07 all other monetary aggregates such as the broad money supply and bank deposits exceeded their targets. The world's leading central banks have been marking up their benchmark interest rates. Inflation would seem to be a threat everywhere. Ultimately in India, the battle against inflation can be won only through capacity additions in industry and agricultural revival. As always, macroeconomic policies, especially monetary policy, will have to strike a balance between growth and price stability.