The decision of the Reserve Bank of India (RBI) to raise its policy rate by half a percentage point surprised the market as the widespread expectation was a quarter percentage point hike. And this is not the only surprise in the Indian central bank’s quarterly review of monetary policy. There are other surprises too. For instance, RBI has admitted that growth is slowing, but has not changed its growth projection for the year, even though the year-end inflation projection has been raised from 6% with an upward bias to 7%. Unchanged at 8%, the growth projection for fiscal 2012 seems a bit optimistic at this point.

But the biggest surprise is perhaps the tone of the policy—the way it has blamed the government for doing nothing to fight the persistently high inflation. The rate hike, going by the RBI statement, is to “maintain the credibility of the commitment of monetary policy to controlling inflation". But more important than that, its objective is to “reinforce the point that in the absence of complementary policy responses on both demand and supply sides, stronger monetary policy actions are required".

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This is the second instance of a half percentage point rate increase since the beginning of the tightening cycle. In March, too, RBI had raised the policy rate by an identical margin but that was on expected lines, at least for a section of the market. But this time around, RBI governor D. Subbarao’s determination to fight inflation is refreshingly different. In the “outlook and projections" section of the policy statement, three paragraphs have dealt with “growth", while 11 paragraphs have been used to highlight the gravity of the high inflation scenario.

Subbarao has also refrained from giving any guidance, and merely said: “Going forward, the monetary policy stance will depend on the evolving inflation trajectory." To that extent, it’s an open-ended policy and no one can guess whether RBI is coming close to the end of the rate-tightening cycle. The market is factoring in one more rate hike by October.

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The next mid-quarter review of the monetary policy is on 16 September and the second-quarter review is on 25 October. Since Subbarao’s three-year term will end on 6 September, this would have been his last policy unless he gets an extension. This possibly explains why he has been so bold in taking action and candid in criticizing the government’s inaction in tackling high inflation.

At one place, the policy document says: “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." At another place, it lists the high fiscal deficit as a key source of demand pressure and one of the key risk factors.

One can always say that the RBI governor could have shown this determination earlier and raised rates more aggressively instead of staying behind the curve most of the time, but that does not in any way dent Subbarao’s argument that the government is doing nothing to address macroeconomic concerns.

Apart from tackling supply-side issues and infrastructure bottlenecks, the government can also raise indirect taxes, such as excise on automobiles, to dampen demand and fight inflation. If it does not do so, and monetary tightening alone has to fight the persistently high inflation, the damage to the growth story will last longer.

Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Your comments are welcome at