The Hindu Business Line : The right monetary signals

Whether wholesale edible oil prices stay cool over a sustained period or not, the significance of the immediate downturn in prices following the duty cuts can hardly be denied. The immediate impact indicates how fiscal policy can be used to curb raging prices. That reductions in customs duties were necessary was fairly clear when global grain prices began to harden and the nation was importing inflation with wheat. But belated action is better than no action at all.

New Delhi’s initiative and benign factors such as a cooling of global prices and the prospect of healthy rabi crops augur well for some more easing of food and general prices. New Delhi is also trying to rein in metal prices — another cause for the inflation rate shooting up. In the event, what should the RBI do? In less than four weeks the central bank will announce its monetary policy for the new fiscal. The temptation to maintain the status quo or, as some bankers feel, to raise the Cash Reserve Ratio and interest rates in order to address inflation concerns must be resisted. A tight monetary policy will not ease supply-constrained inflation; on the contrary it will dampen the growth sentiment even further. With most leading indices reflecting declining output, and with business confidence ebbing even as food inflation rises, the RBI must consider using monetary policy to reverse the trend. The best way for it to do so would be to ease interest rates with the assurance that the government is doing all it can to tackle the supply shortages now fuelling the price rise. The central bank has so far recoiled from easing interest rates because of its belief that inflation is a result of too much liquidity that feeds excess domestic demand. But the source of excess liquidity lies elsewhere than domestic demand, that has been curbed far more than is good for the economy. With the US interest rates now dropping far below domestic rates, capital inflows are surging. Foreign currency reserves have grown by $35 billion between December 2007 and end-March, when they totalled $294 billion; these flows highlight the differential in US and Indian short-term money, for example, and in turn the cost of sterilising the flows with high interest bearing bonds to maintain liquidity at safe levels.

Lower interest rates would reduce the pressure of capital inflows and transmit positive signals about demand in the domestic economy. But most of all, they would sustain growth so necessary to help the marginalised segments now hit by rising food inflation. That is the best the RBI can do today.

Related Stories:
Wholesale prices of edible oils drop sharply
Govt on overdrive to control food prices
Customs duty on cooking oils slashed

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