The Hindu Business Line : Coping with the flow

Most monetary policy reviews of the Reserve Bank of India resonate with old concerns, the principal one in the central bank’s view being “price stability”. The RBI’s first policy review for fiscal 2007-08 is no different but it also echoes a new anxiety. Inflation in developed and emerging economies consequent to hikes in commodity and energy prices, increased capacity utilisation and, therefore, rising wages have prompted most central banks to with draw “monetary accommodation.” In hiking the Cash Reserve Ratio (CRR) by 50 basis points to 7 per cent, the RBI is following a global trend. That it has left the Bank Rate unchanged as also both repo rates in no way lessens the impact that the apex bank would exercise on liquidity in what is clearly a stubbornly demand-driven economy. And that is where the RBI’s problems really begin.

An ideal scenario from the central bank’s viewpoint would be one in which it can control by physical or monetary measures the inflow of capital that is causing it such headaches. Not too long ago, the chairman of the Prime Minster’s Economic Advisory Council hinted at limits when he reckoned that $25 billion a year was a manageable level for monetary authorities. But global investors are not listening; between March and July, the economy received $22 billion in foreign direct investments, equity and External Commercial Borrowings (ECBs). So the RBI has to resort to monetary measures and it is doing all it can to keep the rupee from strengthening any further. At Rs 40 levels, non-oil imports are cheaper but gains that accrue will be offset by spikes in energy prices even as exporters sob at the sink.

Thus, in this first quarter review the RBI has had to balance so many interests with its limited measures that it opted for the one it is confident of serving well — price stability. At the core of its “policy hierarchy” lies its concern to switch off as many taps as it can. Sterilising capital inflows increases money supply so the CRR is raised to reduce the resources available to banks. On a limited scale, the strategy pays off. Non-food credit growth declined to 24.4 per cent in early July from 32.8 per cent a year ago; but money supply accelerated five percentage points from the RBI’s projections of 17 per cent over the same period. That surge and the prospect of sustained inflation are the result of capital inflows. Fifteen years ago, the test of ingenuity lay in increasing the flow; today it lies in managing it.

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