Money & Banking

‘50 basis point hike would have disrupted growth'

N.K Kurup Mumbai | Updated on November 09, 2017

We debated between 50 and 25 basis points and we felt that 25 now would be more consistent with the balance between growth and inflation. — Dr. Subir Gokarn, Deputy Governor of Reserve Bank of India.   -  BL

The Reserve Bank of India has revised its baseline inflation projection from 5.5 per cent to 7 per cent for March. Several hikes in key policy rates in the past one year by the RBI failed to have the desired effect on inflation which remained at 8.4 per cent in December. In the latest review of its monetary policy, the central bank said the “need is to persist with measures to contain inflation and anchoring inflation expectations”.

Dr Subir Gokarn, Deputy Governor, explained the rational of RBI's policy actions.

RBI has revised its inflation projection from 5.5 per cent to 7 per cent, but you have gone for only a 25 basis point hike in key rates. Analysts say this shows the helplessness of RBI. Is it so?

When you are looking at the revision in the inflation projection for March, keep in mind that the jump in inflation from November to December, about 90 plus basis points came from food and energy. Now these were supply shocks which we did not anticipate. The outlook up to March now takes into account the fact that inflation in prices of these commodities will remain high for sometime. In that sense, the projection is a simple reflection of these stronger supply side forces.

The non-food manufacturing inflation which is what we consider, to be the indicator of demand pressures, only contributes 18 basis points to that jump. That number has of course gone up a little bit year-on-year. It was 5.4 in November and 5.3 in December. So there is some pressure. But it is not as dramatic as the headline number. So our concern is with that number. We are already trying to contain the spill-over of the supply shock into that number. We keep that number as the benchmark against which we look at our actions. Based on that, we felt that 25 basis points (hike) was appropriate, even though the projection is for the aggregate — the headline number that include the supply factors. Some of the supply shock will obviously dissipate — we have already seen vegetable prices going down.

But since oil prices are going up and companies are now passing on the hikes in petrol, that pressure is also likely to continue. That is the basis on which we went up to 7 per cent. But the policy was really more in response to the pressure we saw on non-food manufacturing sector.

Why haven't you gone for a steeper hike, say, 50 basis points each in repo and reverse repo?

The 50 basis points hike, we felt, might have actually disrupted growth, given the liquidity conditions and keeping in mind that call rates are already above the corridor, without necessarily having an impact on inflation, bulk of which is in any way now coming from the supply side forces.

Of course, we debated between 50 and 25 basis points and we felt that 25 now would be more consistent with the balance between growth and inflation. We have also given the guidance that we intend to persist with our anti-inflationary stance.

Are we entering a dangerous zone where inflation is going out of control and the response of both monetary and fiscal policies to rein in inflation are tepid?

I think there is a strong element of transitory shocks in the food price situation. The policy response to food prices can be of two types. One, there could be some kind of buffer stock which allows you to manage the prices (like we have for cereals). As new supplies come in, particularly on the vegetables front, that pressure will go down.

There are of course, some structural issues in relation to supply of proteins, for which there has to be a policy response.

When the inflation number went up from 7.5 to 8.4, lot of it came from transitory shocks.

With the projections made in 2010, the Finance Minister did indicate a three-year time-frame to bring down the deficit and based on the growth projections we expect that will not be a difficult objective.

But there are risks. If food, oil and fertiliser prices continue to rise, then the government will have to make a choice between passing on the price increase or increasing the subsidy. Both of them have consequences.

The Policy pointed out that rapid credit growth without a commensurate increase in deposits is not sustainable. What is the message to banks?

We are not giving banks a particular instrument by which to increase the deposits or lower credit. But the gap between the two currently looks unsustainable. Effectively what is happening is that a lot of the credit growth is financed by overnight borrowings from the repo window. We believe that kind of model is not sustainable beyond a point.

The message to banks is that if there is structural liquidity deficit, which is the outcome of that difference (between deposit growth and credit growth) they will have to find ways to overcome it .We are not going to accommodate the structural deficit. We took liquidity easing measures to accommodate frictional component of the deficit, which was seen with the build-up of the government cash balances.

We do not want to accommodate the gap between credit and deposit growth. That is something the banks have to deal with themselves. One obvious solution is that they have to mobilise more deposits.

Do you see increased credit flow to any particular sector, which is not desirable?

The data and banks both tell us that credit flow is balancing out now. So while infrastructure remains perhaps the largest claimant of credit, it is not concentrated as was the case earlier. It is reflecting the broadening of the activity in the economy.

Published on January 25, 2011

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