INFLATION: RBI MEANS BUSINESS

Rising prices has been a growing nightmare for the common people. The Reserve Bank of India, aware of this, sent out the strongest signal ever about its intention to curb inflation and inflationary expectations in its third quarter monetary and credit policy on Friday. It raised the cash reserve ratio (CRR), i.e. the cash that the banks have to keep with the RBI, by 75 basis points. The move will withdraw Rs 36,000 crores from the banking system in two phases. This is not much if you consider the immense liquidity of over Rs 1 lakh crores in the system, but it sends a strong message about inflation concerns while not curbing the lending capacity of banks, which fuels industrial growth. The good news is that the bankers have told the RBI that there would be no immediate hike in interest rates so borrowers, whether for homes or autos, can still take advantage of the low interest rate scenario. Interestingly, despite the fears expressed by the RBI on "teaser" interest rates by a few banks, there has been no major increase in demand for housing loans. Till November, according to the RBI's own figures, housing loans grew by just seven per cent.

 

The RBI revised upwards it inflation figures for March 2010 to 8.5 per cent from the 6.5 per cent it had projected in its October policy, and also its GDP growth figures to 7.5 per cent from seven per cent in October. It, however, expects inflation to moderate from July 2010 onwards provided crude prices remain stable and there is a normal monsoon. Food prices have been the real culprits behind rising inflation. The wholesale price index would have been 7.3 per cent, the RBI said, had it not been for food prices contributing about 2.1 per cent. While the good news is that the economy is on the growth path, the not so good news is that this growth is not uniform. It has been restricted to the auto sector, consumer durables and, partly, construction, which have boosted the steel and cement industries. But the vast services sectors, like tourist arrivals, cargo handled at sea ports, and services dependant on external demand like exports, either declined or showed decelerated growth. Much of the growth, at least two per cent of GDP, was due to the implementation of the 6th Pay Commission awarding arrears. The RBI governor, Dr D. Subbarao, made it clear that while the RBI has started its exit from the accommodative monetary policy that it has maintained in view of the fallout of the global financial crisis, the government of India would have to do the same with its fiscal policies if the monetary polices are to be effective. It will have to roll back its borrowing programmes and unwind its huge fiscal deficit, which is 5.5 per cent of GDP. The RBI governor hoped the government in its coming Budget would indicate its intentions through a road map for fiscal consolidation and spell out the broad contours of its tax policies and expenditure compression. The RBI said it will keep monitoring the situation as there are still large pitfalls ahead. Both global and domestic recovery have been driven largely by government spending and commodity prices have consequently risen. The other major risk to the economy, particularly to the emerging markets, including India, which have recovered faster, is capital flows. Dr Subbarao said that so far capital flows to India have been manageable, but if they go beyond control they could add to inflationary pressures.

 

At the end of the day the economy will be on a stronger footing if there is a better balance between private sector spending and government spending. This is one of the reasons why the RBI did not touch the interest or repo rates.