Unrelenting focus

Just a day before its quarterly review, the Reserve Bank of India in its overview of the macroeconomy left no one in doubt that it would continue with its aggressive anti-inflation stance. Since the beginning of 2010, this has seen the policy rate go up by 4.25 percentage points, in 10 instalments. Over May and June, there have been two hikes aggregating 0.75 percentage point. The backdrop to the latest policy review has not been radically different from the recent past. Inflation remains unacceptably high. Growth has been moderating but, by most yardsticks, is still at comfortable levels. In its annual policy statement, the RBI explicitly stated that over the near term it was willing to sacrifice growth for containing inflation. Sustained inflation over long term will definitely derail growth. On the eve of the policy review, there was a near consensus among leading market participants that the RBI would signal “a pause.” In the event, the hike in the policy rate by 0.50 percentage point has come as a surprise. The repo rate is now fixed at 8 per cent and the reverse repo at 7 per cent. Monetary policy's trade-off between growth and inflation continues to be sensibly tilted towards restraining inflation.

The reasons, according to the RBI, are compelling. Actual inflation has been even higher than expected. Non-food manufactured product inflation is significantly higher than the six-year average of 4 per cent. Crude oil prices remain volatile. The recent increase in the administered fuel prices and the minimum support price for certain foodgrains will add to the inflationary pressures. On the other side, the slowdown in the growth momentum has so far been confined to a few interest-rate-sensitive sectors. Several indicators such as exports and imports, indirect tax collections, and the demand for bank credit suggest that the growth rate is moderating, but only gradually. Although the impact of past monetary policy action continues to be transmitted, it is necessary to persevere with the anti-inflation efforts, considering the overall growth-inflation scenario. The RBI has raised its projection for inflation as on March 31, 2012, by one percentage point to 7 per cent. As for growth, it sees no reason to change its earlier projection of 8 per cent, which was based on the assumption of a near-normal monsoon and petroleum prices ruling at around $110 a barrel. There are significant downside risks to growth and upside risks to inflation. Not for the first time, the RBI has emphasised the role of the government in easing supply side pressures — especially on the food and infrastructure fronts — and in controlling the fiscal deficit.

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