RBI will persist with anti-inflationary stance: Subbarao

The RBI's stance is and will continue to be anti-inflationary, even as it strives to strike a balance between growth and inflation, said the RBI Governor, Dr D. Subbarao.

Admitting that monetary policy is not an ‘effective' response to tackling supply side inflation, he stressed that inflation pressures, if left to persist, would lead to hardening of inflation expectation.

Is the 25-basis-point hike in key rates enough to tackle inflation, which is supply-side driven? Where do you see inflation going forward?

It is true that inflation is driven by supply side factors and for that monetary policy is not always an effective response.

However, we do recognise that supply side inflation will spill over into a generalised inflation. We recognise that if inflation is left to persist, it will lead to inflation expectations hardening.

The dilemma for the RBI is how to balance growth and inflation.

Whenever there is rising income, as is happening now, it quickly translates into demand side pressures. So, our challenge is to restrain demand side pressures in the short-term but support supply side responses.

We will need to persist with our anti-inflationary policy stance. We expect the transient component in food inflation to unwind.

Some of the structural responses may come in. Importantly, monetary policy responses will have an impact.

Inflation will come down in 2011-12, but the pace will be slower than we expect.

The RBI is concerned about credit growth outpacing deposit growth. Do you want banks to lower credit for the rest of the year or would you rather have them increase deposits? What is the message?

Credit growth today is 24.1 per cent, against the indicated projection of 20 per cent. Deposit growth is 16.5 per cent, against the indicated projection of 18 per cent. Clearly, there is a wedge between deposit and credit growth. And that is the structural factor responsible for liquidity deficit.

Over the last few months we have done several things to ease the liquidity situation, but there is a limit to how much the RBI can do. Both the structural and frictional factors have to unwind. The frictional factor will unwind as the Government starts spending. So we expect frictional factors to resolve normally in the next few months. But banks will have to resolve the structural factors.

We told banks that they must increase their deposit rates and restrain their credit. The credit and deposit growth have to be aligned.

Additionally, we will monitor credit-deposit ratio closely and use supervisory responsibilities to ensure that those banks which are far out of line are brought in line.

What support are you seeking from the Government on making monetary policy more effective?

For monetary policy to be effective there has to be fiscal consolidation.

Crowding out is becoming more and more of a distinct possibility. Fiscal consolidation is important.

The second point is how fiscal adjustment will take place in the face of increasing commodity prices, particularly crude oil and fertiliser. If the Government absorbs higher oil price in the fisc, fiscal adjustment will become a problem and there will be inflationary pressures coming from the fiscal deficit. If the Government decides to pass it on to consumers, there will be inflationary impact through the price increase.

So it is a difficult issue for the Government. We have told the Government that between the two it is important to focus on fiscal consolidation for the long term.

What would be the impact of policy rate hikes on loans given by banks? Will they become more expensive?

If monetary policy transmission works as we want it to, lending rates will have to go up and loans by banks will become more expensive.

What will be the impact of capital outflows?

This year in 2010-11 the current account deficit will be 3.5 per cent of GDP and we don't foresee any problem in financing that.

But next year, we want current account deficit to narrow down and we want that to be financed by more stable flows.

This year there has been continued monetary easing in advanced economies. As a result financing of CAD has not been a problem.

If advanced economies recover, the relative attractiveness of bringing money into emerging economies is reduced. So, it is a risk factor.

But we don't see a serious problem in financing the CAD. We need to be concerned about what types of flows are going to finance the CAD.

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