The Hindu Business Line : RBI comes swinging

With inflation stubbornly refusing to recede from 6.5 per cent, it should have come as no surprise when the Reserve Bank of India late Friday announced yet another hike in the Cash Reserve Ratio (CRR) by 50 basis points and the repo rate by 25 basis points; the first raise, to be put through in two phases starting mid-April, will take the CRR to 6.5 per cent and impound close to Rs 15,500 crore from the banking system. The repo rate hike will make borrowings from the central bank more expensive at 7.75 per cent. Predictably, banks will now ponder a fresh hike in loan rates and gamble on enhanced deposit rates getting them more funds. All in all, the banking system is in for exciting times to say the least in the fiscal that has just begun as it readjusts its balance-sheet on the basis of yet another re-pricing of its assets and liabilities. Ostensibly, that is not the purpose of the RBI's moves; the aim is to fight inflation and usher in price stability.

That is where the problem starts. Since end 2004, when the RBI began to use its liquidity-compression instruments it has had a misplaced faith in them to do more than they actually can. They can adjust liquidity and thereby re-calibrate credit offtake; the surge of forex reserves that floods the system with rupees can be adjusted to keep a balance to ensure a competitive currency. But inflation-fighting is a different ball-game in India given the nature of the growth process over the last three years and the sources of the overheating that the RBI is attempting to douse. Time and again, policymakers in New Delhi, and the RBI itself, have made it clear that inflation is the result of supply constraints. For a time, the Finance Ministry made lack of foodgrains and other essential commodities the villains of the piece; so far all attempts to dampen those prices by imports have failed. In New Delhi there is a paucity of perspective; the reality of systemic shortages in cement and steel, power outages even in the most developed States, let alone the hinterland, are recognised in rhetoric alone. For the solution, almost instinctively, New Delhi turns to Mint Street.

Given the unevenness in growth between sectors and regions, it would be ironical if the RBI's almost routine response did not actually pull back what is basically a healthy growth pace. Much as the RBI may claim that its current hikes are temporary measures to prevent liquidity brimming over, their implications for an economy with endemic shortages and therefore vast growth potential are ominous. Unintentionally, the RBI may be fighting not inflation but growth itself.