Inflation has been rising in all emerging market economies and central bankers of these countries are tightening monetary policy to fight runaway prices. But, none of them has demonstrated as much aggression as Reserve Bank of India governor Y.V. Reddy to take on inflation.
The consumer price inflation in China went up to 7.1% in June from 4.4% a year ago. The People’s Bank of China has raised banks’ cash reserve ratio (CRR), or the money that commercial banks are required to keep with the central bank, by 200 basis points between March and June, but left its policy rate unchanged.
One basis point is one-hundredth of a percentage point.
In Korea, inflation has more than doubled in the past one year, from 2.5% to 5.5%, but the Bank of Korea has left its policy rate unchanged so far this year. In Thailand, the consumer price inflation has zoomed from 1.9% to 8.9%, but the central bank has raised its policy rate by only 25 basis points to 3.5% after keeping it unchanged since July 2007 when it had cut it by an identical margin.
In Indonesia, inflation has risen from 5.8% a year ago to 11% in June and is predicted to reach 12.5% by the year-end. The Indonesian central bank has raised its policy rate by 75 basis points in stages since end-March. This is after raising the policy rate by 475 basis points between May 2006 and December 2007.
The Wholesale Price Index-based inflation in India has risen to its 13-year high of 11.89%, from 7.75% in end-March and 4.76% a year ago. Reddy was initially slow to react. In fact, he left the interest rate untouched in April when he announced the annual monetary policy, even though he raised CRR. But, he is not one who wants to be left behind the curve for long. A three-stage 125 basis points hike in policy rate in two months is testimony to that. And CRR is now up by 150 basis points in four phases since April.
This marks a clear shift from an expansionary monetary policy to a mildly restrictive monetary policy, warranted by the inflation dynamics. It’s “mild” because inflation has not yet peaked and nor has the interest rate cycle in India. Even if the monsoon is on course and there is no hike in the domestic fuel prices, the inflation will probably cross 13%. It may even inch up to 15% if the distribution of rainfall is not even across the country (as that will impact food prices) and internal crude prices surge again, forcing the government to raise fuel prices. Even after the latest hike, the policy rate is still negative by a wide margin (inflation at 11.89% vs repo rate, a key short-term lending rate, at 9%). At least another round of hike in the interest rate as well as CRR can be expected before the year-end.
The last time India had seen a rate cut was in August 2003. Ever since Reddy took over as governor in September 2003, he has not cut the policy rate or banks’ CRR even once. In fact, during his regime, the repo rate, or the rate at which RBI infuses liquidity into the system, has gone up by 300 basis points, from 6% to 9%, and the reverse repo rate, or the rate at which RBI drains liquidity, by 125 basis points, from 4.25% to 6%. The hike in CRR has been 425 basis points, from 4.75% to 9%.
In his last policy review, before he hangs up his boots this September, Reddy has demonstrated his strongest commitment to fight inflation. Had he not done so, Reserve Bank’s credibility would have been compromised. Indeed, the asset prices will be affected and there will be a slowdown in economic growth in the short run. But that’s a small price to pay for taming the hydra heads of inflation.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai bureau chief of Mint. Please email comments to email@example.com. To read all his earlier columns, go to www.livemint.com/bankerstrust.