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The RBI does it again! - Views on News from Equitymaster
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  • Dec 11, 2006

    The RBI does it again!

    Citing the continuance in strong economic growth and heightened chances of having an overheated economy, the Reserve Bank of India (RBI), on Friday, raised the CRR (cash reserve ratio) by 50 basis points (0.5%), effective in two stages over a period of next 30 days. While the CRR will rise from the current 5% to 5.25% on December 23, 2006, there will be a further 25 basis points rise effected from January 6, 2007.

    In raising the CRR this time, the RBI hinted at its earlier statements made in October 2006, during the announcement of the mid-term review of the annual policy for the year 2006-07. The central bank had then stated, "containing inflation expectations in the current environment and consolidating gains achieved so far in regard to stability would warrant appropriate, immediate measures and willingness to take recourse to all possible measures in response to evolving circumstances promptly. The objective is to continue to maintain conditions of stability that contribute to sustaining the momentum of growth on an enduring basis. Towards this objective, the monetary policy stance and measures will need to be in a process of careful rebalancing and timely adjustment." The latest hike in the CRR suggests part of this process of rebalancing and readjustment from the RBI.

    The central bank has outlined some recent developments, particularly on the domestic front, that have influenced its latest stance. Some of these include:

    • The Indian economy has grown at a real (inflation adjusted) rate of 9.2% during July-September, 2006 and 9.1% during the first half of FY07.

    • Non-food credit has continued its strong momentum, increasing by over 30% YoY during the period April to November 2006 (31% YoY growth during the corresponding period of previous year). The overall growth in money supply has been over 19% YoY during this period.

    • On the back of strong economic growth and buoyant credit offtake, combined with higher prices of commodities, the inflation (as measured by the wholesale price index or WPI) was at 5.3% at the end of November 2006 (4.1% at the end of March 2006).

    • Importantly, the inflation at the consumers' level (as measured by the consumer price index (CPI) for industrial workers) was at a high of 7.3% in October 2006, from 4.2% a year ago.

    • The RBI has also cited its study of the private corporate sector, where it has indicated higher increase in prices of both inputs and outputs. Also, on the back of robust growth in domestic demand and inconsequential growth in capacities, there have been growing strains on capacity utilisation. Also, while expansion of capacity across most of the industries is underway currently, the benefits from the same are likely to be realized only over a period of next two years.

    If one goes by the recent actions of the RBI and some of the other central banks in the world (England, Turkey, Thailand), there has been a move towards greater intermediation, as demanded by he prevalent economic situation. Monetary policymakers no longer wait for the 'Monetary Policy announcement date' to make clear their intentions, and rightly so. The world economy, over the past few years, has integrated at such a rapid pace that it has left little flexibility in the hands of national monetary policymakers to make decisions as and when they want. Today, economies dance to 'one' global beat and those who miss the step might do more harm than good to their economic policymaking. The Indian central bank, the RBI, is following the same.

    As far as inflation in the Indian economy is concerned, we believe that it is not solely a factor of pressures like higher commodity prices. Rather, the inability of capital productivity to match pace with capital utilisation is what has hurt us more in the past. Frequently, the early stages of an economy's expansion include a period of above-trend growth, as underutilised resources are put back to work. As slack in the economy is reduced, however, economic growth tends to moderate. Indeed, at that stage, some slowing of growth to a pace consistent with the rate of increase in the nation's underlying productive capacity is necessary if the expansion is to be sustained without a buildup in inflationary pressures. We, as an economy that has relied a lot on that 'incremental' capital for achieving a lower incremental growth, need to learn this fast if we have to protect ourselves from overheating.



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