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Inflation revisited – Options for the Reserve Bank of India - Views on News from Equitymaster
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  • May 9, 2000

    Inflation revisited – Options for the Reserve Bank of India

    "On the inflation front there is need for continuous vigilance and caution." - Bimal Jalan, Governor, Reserve Bank of India in the Statement on the Monetary and Credit Policy for the year FY01.

    Inflation has been rising incessantly over the last couple of months. As compared to the average rate of 3.7% during FY00, inflation is currently at 4.6% (latest available final figures, subsequent figures are still higher). In such a scenario the Reserve Bank of India must be finding itself in an unenviable position, where the option is either to support industrial recovery or contain inflation.

    The Indian constitution fails to stipulate an inflation target for the Reserve Bank of India (RBI) and therefore there is some arbitrariness involved in determining the acceptable level. Dr C Rangarajan in a study had concluded that a rate no higher than 6% should be acceptable. Given this standard we are well within the limit. However, prices (in particular energy prices) are rising unabatedly. There is thus a need to check prices now rather than waiting for them to cross ‘the limit’ – as measures themselves would take sometime to take effect.

    Now, the question that arises is whether in its attempt to control inflation (by raising the cost of funds) would not the RBI be hurting business activity. Yes, it would. So how should the RBI go about controlling inflation without nipping the economic recovery? This is where the situation gets sticky – inflation and growth are the two sides of the same coin (no goldilocks here!).

    Inflation in India is an election issue. That there are no elections in the near future should indicate that the RBI would probably overlook inflation figures for sometime (it is already doing that). So for the time being the RBI can keep pursuing its pro growth policies. However, even in the near term, there is a possibility that persistent rise in inflation could begin to hurt the economy in terms of a weaker currency (leading to higher cost of imports) and even more the poorer sections of society that have no hedge against this menace. In such a scenario a rate rise is both desirable and necessary.

    The RBI has to constantly walk the tight rope while deciding whether to support growth or control inflation. In the coming weeks the RBI may find itself facing one of its toughest tests in recent years. No matter what the policy pursued, opinion on results would almost surely be mixed – with either the masses or the industry emerging as beneficiaries. Unless of course RBI achieves the ideal situation of persistent non-inflationary growth (the goldilocks economy).



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