A clear task for RBI

A clear task for RBI

There are two inflationary outlooks in India. One is that of the government, which expects inflation to come down after two months. When the two months pass, it issues another statement saying that prices will cool after another two months and so on. The other outlook is that of individuals who have to bear the brunt of prices on fire. Here the outlook is bleak and no one believes that prices will climb down anytime soon.

On Tuesday, when the Reserve Bank of India (RBI) undertakes a quarterly review of monetary policy, one hopes it will give credence to the runaway rise in the price level. There is ample evidence that it is. In June, the Wholesale Price Index (WPI) rose by 10.6% (on a year-on-year basis), the fifth month in a row when prices have remained in double digits. Inflation today is generalized: all components of the WPI, primary articles (basically food, minerals and non-food crops), fuels and manufactured products are on fire. Primary article prices rose by 16.3% in June, fuels by 14.3% and manufactured goods by 6.7%.

This clearly warrants an increase in the repo rate, or the rate at which RBI lends money to commercial banks. If RBI does increase the repo rate, it should be seen in the right perspective: It will not be monetary tightening, but a return to a rate that is normal. The tremendous monetary relaxation, which many have come to regard as the “new normal", was the product of the extraordinary global circumstances of 2008-09.

When RBI began the downward march of interest rates in the third quarter of 2008, inflation was in double digits, as it is now. But at that time the repo rate was 2.5 percentage points above what it is now. The reverse repo rate (the rate that RBI pays the banks when they park money with it) was 2 percentage points higher than now. So a higher repo rate will not amount to monetary belt tightening.

While it is no one’s case that there be sudden increases in interest rates, the fact is that RBI is behind the curve on this front. It still has to raise rates by 150 to 200 basis points (bps) before one can say things are back to normal. A 25 bps increase in the repo rate would help in sending the right signal to markets. When seen together with the 25 bps increase in the repo rate earlier this month, it would constitute a step in the right direction.

A higher repo rate: monetary tightening or a return to normalcy? Tell us at views@livemint.com