The Hindu Business Line : Monetary Policy Curtain-raiser

The central bank should not lose steam in its enthusiasm to tame inflation. It should say categorically that it will strive for monetary stability to facilitate orderly growth. This need not necessarily mean a zero inflation rate, but that it can contain inflationary expectations, without setting "tolerable" targets, says A. SESHAN.

WILL THE RBI Governor, Dr Y. V. Reddy strike against inflation? — Paul Noronha.

The guessing game on the likelihood of a further tightening by the Reserve Bank of India (RBI) has already started along with the countdown to April 24 when the next edition of the Monetary Policy will be announced.

A couple of recent significant changes warrant a gloomy outlook. In the first place, the RBI has clearly stated that it has shifted attention from riding the two horses of price stability and growth to giving priority to the former, albeit in the attenuated sense of maintenance of the inflation rate around 5 per cent. Thus, in its press release of March 30 announcing the hikes in the repo rate and the Cash Reserve Ratio, the RBI cited its third quarter review of the year and said: "... a judicious balancing of weights assigned to monetary policy objectives would accord priority to stability in order to support growth on a sustained basis... Accordingly, it is necessary to reinforce the emphasis on price stability and well-anchored inflation expectations...The conduct of monetary policy should continue to demonstrate that inflation beyond the tolerance threshold of the Reserve Bank is unacceptable and that the resolve to ensure price stability is always backed by timely and appropriate policy responses."

RBI will strike

Brave words indeed! Thus there is no more a policy approach of neither here nor there. When the chips are down the central bank would strike hard against inflation.

Second, what has emboldened the RBI to take such a tough stand is the strong support it has received from the Finance Minister. He has applauded the central bank for its anti-inflationary stance and, unlike in the past, left it to pursue its path unhindered by any subtle contrarian hints. This new-found maturity in economic statesmanship may be the result of the Congress party getting a drubbing at the polls in a number of States recently. This trend may continue even more adversely in UP, Goa, Gujarat and Delhi Assembly elections in the near future unless corrective action is taken in time.

There is an obvious recognition that the inordinate price rise of the last one year has contributed to the disenchantment of the electorate with the UPA Government. What is the use of boasting that the country's GDP and foreign exchange reserves are around the levels of $1 trillion and $200 billion, respectively, or that the growth rate is above 9 per cent, if 250 million people below the poverty line are fighting a daily battle of bare survival? Those who cite high GDP growth in favour of an accommodating monetary policy should be reminded about the low rate achieved in the agricultural sector. And 70 per cent of the population depends on this sector for living.

What is distressing is the stand of some economists, especially those trained in the West and employed there in the past, pooh-poohing all these concerns of price rise and arguing that a 6.5 per-cent inflation rate is after all not high enough for the RBI to go into the panic mode and do anything to hurt the growth process. They forget the fact that it comes after many years of sustained price rise. One foreign luminary of an international institution has even argued that it is not bad so long as it does not touch the double-digit level!

Dangerous insensitivity

This attitude is the syndrome of a dangerous trend of insensitivity to the problems of the poor on the part of the upper-middle and richer classes. They recall to mind the heartless words of Marie Antoinette who was reported to have advised the French poor to eat cake if they could not afford bread! She paid the price for that insolence. Social conscience requires that, when the eminent experts hold forth on the inflationary compulsions of a dynamic economy throbbing in growth, they should also give some thought to the poor child foraging for left-overs in garbage. Should not sensitive hearts bleed to witness such sights?

The central bank should not lose steam in its enthusiasm to tame the inflation monster. To reinforce its credibility, it should say categorically in its next policy announcement that it will strive for monetary stability, as mandated in the RBI Act, to facilitate growth in an orderly manner. This need not necessarily mean a zero inflation rate. But it can contain inflationary expectations if it desists from making an astrological prediction of a "tolerable" price rise of 5-5.5 per cent.

When it makes such a prediction it assures the nation of a minimum inflation rate because of the manner in which it makes the estimate of money supply thereby raising inflationary expectations. It "forecasts" the expected growth rate of GDP and multiplies it by the income elasticity of demand for money. That should, in the normal course, be adequate to take care of the additional demand for money due to growth. But it adds a baker's dozen of 5 per cent to accommodate an equivalent inflation rate!

Invitation to Inflation

What will happen if this addition is not made? Will it be good or bad for the economy? These questions have never been answered by the central bank. Looking at the matter from a practical angle, if, at any point of time, insufficient liquidity is coming in the way of growth it can always take corrective action even if the above-mentioned addition is not made in advance. On the other hand, a suo motu addition of 5 per cent to the required money supply is an invitation to inflation.

A 5-per-cent addition today means several times more in absolute values than when this pernicious practice was initiated about two decades ago. Let us not forget that many hyper-inflations of the world started at low rates. A money supply growth rate of 15 per cent indicated in the policy announcements of the past is no longer sustainable without serious consequences. The RBI should wait for some more time to see the results of the actions taken so far before initiating fresh ones. It may perhaps raise the prudential norms. They have a cosmetic advantage from the point of view of public relations. They have money supply and interest rate implications recognised only by the expert and not by the layman.

(The author is a former Officer-in-Charge of the Department of Economic Analysis and Policy of the Reserve Bank of India. The views expressed are personal.)

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