The Reserve Bank of India (RBI) on Tuesday raised the repo and reverse repo rates by 50 basis points (bps). Its aggressive policy posture was accompanied by a stern message: the absence of appropriate steps by the government had put a question mark on sustaining growth without strong inflationary pressures.
As this paper said on Monday, the most important part of the monetary policy review would be what Governor Subbarao said. And what he said on Tuesday is worth repeating. He said that “it is important to recognize that in the absence of appropriate actions for addressing supply bottlenecks, especially in food and infrastructure, questions about the ability of the economy to sustain the current growth rate without significant inflationary pressures come to the fore. The economy’s ability to grow rapidly for any length of time without provoking inflation is dependent on implementing policies, with corresponding resource allocations, which will allow the supply of various products and services to keep pace with demand.”
This is as strong a message as any central bank governor can give to a government. The challenge of containing the fiscal deficit to the target listed in the Union Budget for 2011-12 is already apparent and RBI has noted it. If anything demand-side pressures unleashed by a large fiscal deficit has been listed as one of the four risks to the economy in the months ahead. The other three risks being volatility in global oil prices, uncertainty in the global economy posing risks in financing of the current account deficit and the domestic food inflation—the risk here being due to an adverse monsoon coupled with higher minimum support prices fuelling a price surge.
The RBI’s raising of its baseline inflation projection for March-end 2012 from 6% to 7% should be seen against this backdrop. Clearly, the central bank believes that some amount of suppressed inflation continues to exist in the economy. Under recoveries of oil marketing companies are close to 1% of the gross domestic product. The bank’s guidance made it clear that unless inflation comes to the bank’s comfort level, there may be no change in its policy stance. It is significant that Subbarao has not hinted that Tuesday’s measures mark the end of the rate-tightening cycle.
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