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The Reserve Bank of India desisted from reversing the interest rate cycle last month as the majority of members of its Technical Advisory Committee (TAC) held the view that inflation would continue at the ‘current levels' in the near future.
The headline wholesale price index based inflation, which averaged 9.7 per cent during April-October 2011, moderated to 9.1 per cent in November and further to 6.55 per cent in January 2012. However, it is nowhere near the 4.5-5.0 per cent mark, as per the minutes of a meeting of the TAC on monetary policy released on Friday.
Structural issues such as fiscal slippage, suppressed elements of inflation, increase in input prices due to weakening rupee, high inflation expectations and the wage-price spiral led most TAC members to conclude that inflation would continue at the current levels in the near future.
Liquidity infusion
Instead of cutting interest rates, the central bank chose to cut the cash reserve ratio (a portion of deposits that banks park with the RBI) by 50 basis points to 5.50 per cent to ease liquidity pressures as many TAC members were in favour of such a liquidity infusion measure.
All TAC members expressed serious concern over the evolving fiscal situation. The fiscal deficit target in 2011-12 (budgeted at 4.6 per cent of GDP) was likely to slip significantly. In view of the fiscal situation, some members felt that unless there was a clear signal of credible fiscal consolidation, the Reserve Bank should hold back the policy rate reversal.
Fiscal pressure
Some members observed that fiscal pressure would continue beyond 2011-12 as the monetary impact of entitlements such as Mahatma Gandhi National Rural Employment Guarantee Act (MNREGA), oil, fertiliser and food subsidies would be significant.
The level of inflation expectations, according to some members, was high and the RBI should continue to keep monetary policy tight (at the present level).
It was necessary to bring down inflation significantly from the present level, even if it meant lower growth for the next few years.
It would ensure that high growth was achieved in subsequent years.
Impact on investment
Some members felt that the slowdown in investment would affect the next year's growth as well. Besides, it would also have implications for inflation, going forward.
The members observed that while high interest rates had impacted investment, the overall investment sentiment was also subdued because of structural and confidence issues that had not been addressed.
The TAC's meeting was chaired by Dr D. Subbarao, Governor. Other members present were: Deputy Governors Dr Subir Gokarn, Dr K.C. Chakrabarty, Mr Anand Sinha, Mr H.R. Khan; and external members Mr Y.H. Malegam, Prof Indira Rajaraman, Dr Shankar Acharya, Dr Rakesh Mohan, Prof Sudipto Mundle, Prof Errol D'Souza and Prof Ashima Goyal.
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