Opinion - Editorials

Tougher monetary stance

In choosing to hike the cash reserve ratio (CRR) by 0.50 percentage point just 10 days before it is scheduled to unveil its annual monetary and credit policy statement, the Reserve Bank of India has sent out several signals. It has, for at least three quarters in a row, been emphasising its preference for price stability even at the cost of economic growth. Monetary tightening has therefore been on the cards but it acquired a certain urgency ever since WPI inflation, in the words of the Governor, became “unacceptably high.” Point-to-point inflation has remained above 7 per cent for several weeks running and peaked at 7.41 per cent at the end of March. The RBI’s comfort level is 5 per cent. Though it has not been averse to announcing monetary measures outside its formal quarterly statements, the central bank timed the CRR hike to surprise market participants, who probably expected it to have a minimal role in combating the latest bout of inflation. While it is true that supply side factors are mainly responsible, demand pressures also exist. Money supply has been running well ahead of its targets for three years in succession. At the current juncture, wages have been going through the roof and the demand for cement and steel far exceeds supply. These and other factors require a monetary policy response. Although the CRR is a blunt instrument, the hike is appropriate at a time when liquidity management becomes important. It will impound Rs.18,500 crore of resources in two stages.

The forthcoming policy statement will surely elaborate on the various options. But an assessment of major macroeconomic trends suggests that the RBI may not alter policy rates for now. That would leave the banks to frame their interest rate policies after taking into account the impact of the latest CRR hike. A more aggressive inflation containment strategy is constrained by the fact that the economy is distinctly slowing down even as external demand is tapering off. India is one of the few Asian economies having a current account deficit that is widening because of a growing trade imbalance. There is plenty of uncertainty over capital inflows that bridged the current account deficit and propped up the balance of payments. The RBI has a definite role in anchoring inflation expectations and checking the second round impact of input prices. But just as the government, which is supplementing its fiscal and administrative initiatives with some tough talk including threats of punitive action to bring down inflation, the RBI too is sure to adopt a tougher stance and further rein in money supply.

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