The Hindu Business Line : Tightening the screw

The Reserve Bank of India’s hike in Cash Reserve Ratio on Thursday evening, more than week before its annual monetary policy, has the appearance of a timely contribution to the war on inflation, but at this point victory is still debatable because the weapons used may prove futile to the task. Given that deposits in the banking system swell by more than Rs 12,000 crore a week, the RBI mop-up of Rs 18,500 crore through this measure will not have any dramatic effect on liquidity. Instead, the signal that it sends could perversely hasten the unravelling of the growth story.

The success of the CRR hike and any tightening of interest rates on inflation depends on the degree to which the price rise is fed by excess demand and therefore excess liquidity. For more than six months, both New Delhi and the RBI have stressed the origins of the current inflation in food and oil price hikes, themselves occasioned by external factors, in the case of oil, and in food supplies, largely on account of domestic shortages. Both authorities have called for enhanced investments in the moribund farm sector as a durable solution to scarcity. In the short term, fiscal measures have worked partially to dampen prices. It is also well known that the price hikes affect most that very large section of Indians least equipped with purchasing power and therefore the least likely to fuel excessive demand. In an economy where growth and prices are already pulling in opposite directions and the poor are wedged in between, what should monetary policy do? Higher interest rates will not increase food supplies or lower the price of oil. On the other hand, a flexible interest rate regime could continue to foster growth, help increase the purchasing power of the vulnerable and better equip them to fight the price rise. For the RBI, however, an inflation of seven per cent, regardless of its origins, calls for tightening. The system is awash with liquidity; money supply is around 20 per cent, it avers; monetary policy is pressed into service to trim credit demand. Already, the results are impressive; between October and December 2007, the credit growth of the top 100 centres of banks fell to 21.6 per cent from 32.1 per cent in the same period of 2006; this period is followed by declines in various indicators.

The government surely is aware of the adverse impact high interest rates have had on growth. The Finance Minister has more than once appealed to banks to reduce loan rates. In the event, further tightening would signal a more rigid interest rate regime for retail borrowers, thus dampening credit even further. Strangely, the RBI policy reflects the government’s preference for short-term expedients to durable solutions for inclusive growth.

Related Stories:
Cash reserve ratio hiked by 50 basis points
‘RBI may use CRR, market stabilisation to tackle inflation’
Banks see case for CRR cut as liquidity is tight

More Stories on : Editorial | CRR & Bank Rates

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Tightening the screw

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Inflation

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