The monetary policy dilemma

The monetary policy dilemma

Reserve Bank of India (RBI) governor D. Subbarao will on Tuesday announce the second-quarter review of monetary policy for fiscal 2010. In the past one year, he has cut the policy rate sharply—from 9% to 3.25%—and infused liquidity by cutting the cash reserve ratio, or the portion of deposits banks have to keep with the RBI, from 9% to 5%.

Also See Policy rates, credit, deposit and investment growth (Graphics)

This time around he faces a dilemma—he knows that the expansionary monetary policy should end but is not sure about the timing. While economic growth has started showing signs of recovery with some robust industrial production data in the past few months, economists doubt the sustainability of the growth itself.

At the same time, they also hold the view that inflation is on the rise and there is a high probability that inflation could breach the RBI’s own estimate of 5% by March-end.

A rate hike at this point will make money dearer and dampen inflationary expectations, but it will come at the cost of hampering growth. This policy will be keenly observed by market participants as well as central banking authorities worldwide, as India’s policy steps, surely, will have repercussions in an interlinked world.

The following set of data offer a peek into the state of affairs in the Indian economy and outline the fiscal and monetary compulsions of the authorities.

Compiled by Ashwin Ramarathinam

Graphics by Ahmed Raza Khan/Mint