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RBI’s choice in uncertain times

RBI’s choice in uncertain times
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First Published: Tue, Nov 02 2010. 08 25 PM IST
Updated: Tue, Nov 02 2010. 08 25 PM IST
The Reserve Bank of India (RBI) on Tuesday raised the repo and reverse repo rates by 25 basis points each. The central bank is likely to pause now before it raises policy rates further.
While RBI has been aggressive since March—it has raised the repo rate and the reverse repo rate six times—inflation remains high. Under the new Wholesale Price Index (WPI) series (base 2004-05), inflation touched 8.6% in September and food inflation continues to be in double digits. Clearly, inflationary pressures have not abated. And as RBI governor D. Subbarao noted in his monetary policy review, inflationary expectations have risen, even if marginally.
There are two aspects to the inflationary situation. Domestically, food price inflation is now the main cause for worry. While this is something that RBI can do little about, it is important to note that the bulk of WPI inflation has come from non-food items (non-food manufactured products + fuel + non-food articles) that have a weight of 75.7% in WPI. This has contributed 65.5% to WPI inflation in September, rising from 40.5% in January. When seen together with emerging capacity constraints in some sectors, it may be too early to rule out problems on this front.
The other risk comes from the global economic situation. Advanced economies continue to maintain very low interest rates and with the spectre of quantitative easing, commodities continue to be attractive as investments. The hardening of commodity prices poses an inflationary risk that may spill over into manufacturing prices. As it is, non-food article inflation continues to be high. In September, non-food article inflation stood at 18.2%. It has remained in double digits through the year.
At the moment, RBI’s comfort levels in managing inflation may be high, given the continuous raising of policy rates. Here the policy choices are quite clear: In case inflation reaches uncomfortable levels, raise the rates further. This choice may not be so simple if there are bigger capital inflows in the Indian economy in response to its continuing growth and uncertainty and ebbing of growth in the global economy. While Subbarao was careful to point out that the rupee has hardly appreciated, as measured by the 36-currency real effective exchange rate, it may pose problems in the future. Given these troubling possibilities, it may have been better if RBI had acted a bit more aggressively in case its hands are tied later by complicated macroeconomic circumstances.
Has RBI given up too soon? Tell us at views@livemint.com
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First Published: Tue, Nov 02 2010. 08 25 PM IST
More Topics: Ourviews | RBI | WPI | Inflation | Views |