RBI's crusade against inflation continues - Views on News from Equitymaster

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RBI's crusade against inflation continues

Sep 16, 2011

The Reserve Bank of India (RBI) declared its mid-year monetary policy review for financial year 2011-12 today. High fuel prices, persistent inflation and expectations of liquidity overhang in global financial markets drove the RBI to tighten the monetary policy noose for the 12th time since March 2010.

The RBI raised the rates at which it lends to banks (repo rate) by 0.25%. Thus the repo rate now stands at 8.25% from 8.0% previously. The rate at which RBI borrows from banks (reverse repo) now stands 7.25% post the review. The central bank left the cash reserve ratio (CRR) unchanged at 6%.

The RBI reiterated that inflation is a huge risk factor that cannot be ignored. Thus the central bank decided that it was too early for it to roll back its earlier stance.It fears that such a move would dilute the effect of the actions undertaken over the past 18 months.

Battling high inflation and slower growth

Headline inflation measured as Wholesale Price Index (WPI) rose from 9.2% in July to 9.8% in August 2011, continuing to remain stubbornly high despite the central bank’s efforts. The oil marketing companies (OMCs) recently responded to high crude prices by hiking petrol prices by Rs 3.14 per litre across the country. Currency depreciation and higher crude prices globally are putting pressure on India’s oil bill and OMCs’ bottom line. According to the RBI, the petrol hike is expected to have a 0.07% direct impact on the WPI. Food inflation in country is also above comfort levels. This is despite a good monsoon this year. However, inflation may ease towards the latter half of the fiscal year even if it is under pressure for the next couple of months according to the RBI.

The global economy has seen a slowdown over the last quarter. There are renewed fears of recession on the back of the Euro sovereign debt crisis. A slowdown in the US economy is also highly apparent. Emerging economies on the other had have seen growth, albeit at a slower rate. In India, GDP growth decelerated to 7.7% in 1QFY12 from 8.8% in 1QFY11. The Index of Industrial Production (IIP) slowed from 8.8% YoY in June to 3.3% in July 2011. However, on removing the change in capital goods which is usually volatile, the fall was not as sharp. Rather than keeping growth intact, the RBI continues to target inflation, unlike its other counterparts in other parts of Asia and Brazil.

The path forward

High crude oil prices, steep industrial commodity prices and the RBI’s monetary tightening will weigh on India’s economic growth in the near term. A weak global economic environment and rupee depreciation (which hurts imports) are also worrying factors. Money supply growth and credit growth were above RBI’s projections in August 2011. However, in light of the latest round of tightening and the faster transmission of monetary policy, credit growth may see a further dip. Consumer demand is expected to slowdown, which could help in cooling inflation. Growth in sales of interest rate sensitive products like passenger cars has already been impacted. Corporate profits have also fallen on account of higher borrowing costs. The RBI expects its monetary policy actions to play a part in bringing down inflation. Even though the central bank is well aware of the counterproductive impact of steep interest rates, the balancing act between growth and inflation control is a tough one.

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5 Responses to "RBI's crusade against inflation continues"

Manish Grover

Sep 18, 2011

I am not an expert in economics but cant understand the logic of contradictory actions by different decision makers. On one end RBI hikes rates and on the other petrol price are hiked, doing more than nullyfing the effect of rate hike. On one end GOI talks about subsidizing OMCs for Diesel, Kerosene and Gas cylinders and on the other end, state and central government charges high taxes on same products. Is there any rational logics in these decision??Please correct me if I am wrong anywhere.

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thejas

Sep 17, 2011

We cannot blame RBI for government's failure. Look at its track record, they are considered as one of the best central banks in the world.

The problem is the government. India is becomig a banana republic. The decisions are made for the the corporates and not for the people. Government is collecting money for the next scam and helping corporates to multiple their profits. Sure they will be sharing the profits with politicians. Unfortunately we have a wrong person as our PM.

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Ravi

Sep 16, 2011

Steal it from Ram to pay Shyam, but Shyam loves to party. How long can we support partying Shyam.

Subsidizing diesel so our partying shyam .. who loves SUV's can have fun. The poor who is suppose to use diesel does not even have proper bicycle forget about tractor.

If economy is dependent of diesel lets remove subsidy bite the bullet. We import oil, we have to find efficient ways to use it not innovative way to bankrupt ourself.

when bunch of moron's run country ....this what happens.

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Kunal kumar Kundu

Sep 16, 2011

I continue to be flummoxed by RBI. Last year the erred on the side of caution, by clearly failing to anticipate the inflationary pressures that were building up (remember then even did the unprecedented thing of increasing their inflation forecast by a percentage point within a month). Now they are erring on the side of being excessively hawkish. The only time I agreed with them was their previous action of a 50 bps hike. They should have done this much earlier to kill the inflationary expectations. From their initial movements, most of the banks took nearly six months to respond. Hence the transmission was weak. Thus, with the rising negative real interest and surfeit of liquidity, credit flow increased and demand grew. By now the impact of the monetary policy is pretty well entrenched. Most of the indicators are showing that, be it credit growth, flow of finance to micro and small industries, rapidly rising time deposit etc. While input prices are rising (mostly of minerals which are imported) output prices are rising ever so slowly, indicating a rising squeeze of producers’ margin. Only indicator that is not budging much is inflation. What this means is that it is hugely structural and there's only so much that a monetary policy can do. Fact is, there is clear sign of demand destruction happening. Inflation has peaked save for some fluctuations. If one takes a 3MMA IIP data, the downward trend is also quite clear. With inflation at double digit or more for nearly two years now, the base effect and falling demand will ensure moderation of inflation going forward. Not surprisingly Anirvan of ECRI criticizes central banks worldwide for lack of forward looking indicators to base their decision making on. This essentially also means that RBI should have stopped after the last hike but since they do not have forward looking data, they are unable to gauge the lagged impact of the sustained monetary policy action.

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MUNSHI LAL

Sep 16, 2011

Necessary to curb inflation. Hike in petrol prise is wrong .It must betax free at least .

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