S S Tarapore

Baby steps cannot curb inflation

Updated on: Apr 21, 2011

In its first monetary policy review this fiscal, the RBI should jettison half-hearted measures and go for an unequivocal anti-inflationary thrust. There is scope to increase the cash reserve ratio and place limits on credit growth.

The Reserve Bank of India (RBI) will, on May 3, 2011, announce its first Review of Monetary Policy for 2011-12. For the past two years, the spectre of inflation has loomed large, but RBI has consciously opted for ‘baby' steps in its monetary policy, ostensibly on the premise that nothing should be done to slow down economic growth.

The year-on-year Wholesale Price Index (WPI) at the end of March 2011 is close to 9 per cent. The average WPI showed an increase of 9.4 per cent in 2010-11, as against 3.6 per cent in the previous year. The average food inflation in 2010-11 is uncomfortably high at 11 per cent.


The government's policy was clearly tilted towards accelerating growth, and inflation was considered as an inevitable price for growth. The government now recognises that inflation is now strongly wedged into all sectors; there are strong compulsions to control inflation as it is impacting not only the poor, but also the vocal middle class.

The Finance Minister, Mr Pranab Mukherjee, has, more recently, referred to a clear choice between controlling inflation and sacrificing some growth. The Deputy Chairman of the Planning Commission has admitted that a 9 per cent growth in 2011-12 is no longer in the realm of possibility and that we would have to settle for 8.5 per cent. While the RBI will be berated for not taking effective action to squelch inflation, it must, in fairness, be stressed that the overbearing tilt of the government towards growth has made life for the RBI rather difficult.


The window of opportunity for strong monetary policy action is invariably short and the RBI would, in the current milieu, be well advised to jettison its ‘baby' steps and opt for stronger measures.

It is the job of industry to shout from the roof-tops that any increase in interest rates would jeopardise growth. Banks will also argue that any increase in interest rates would reduce their net interest margins. The RBI should not be swayed by these seductive sirens.

The RBI has to take a call on the monetary policy on May 3, 2011, and it would be best if its stance was in the nature of a strong, unequivocal and unswerving anti-inflationary policy.

The present repo policy of 6.75 per cent is out of kilter and ‘baby' steps would not be in consonance with the difficult inflationary situation. The central bank would need to take note of its own Inflation Expectations Survey of Households which reflects an anticipated inflation rate of 13 per cent.

The RBI should, on May 3, 2011, shift gears and move over to at least a one-half of one percentage point increase in the repo rate to 7.25 per cent; in actual fact the need of the hour is a full one percentage point increase, but this would not fit in with the prevailing RBI philosophy.

The apex bank has rightly indicated that it would prefer the banking system to be in deficit mode, which would make the monetary transmission process more effective.

It been reluctant to wield the cash reserve ratio (CRR) instrument lest it result in a cessation of credit. Banks are clearly over-extended with a year–on-year incremental credit deposit ratio of 99 per cent and as such there is no likelihood of any cessation of credit. The RBI should, therefore, increase the CRR by 0.50 percentage point which would impound Rs 25,000 crore and move banks into a deficit mode.

The RBI should set a prudential limit of an incremental credit-deposit ratio of say 70 per cent; any bank exceeding the 70 per cent limit should be subject to a penal interest of 3 percentage points above the prevailing rate at which it seeks access under any RBI facility.


Anticipating pressures on their net interest margins, banks have already started reducing their deposit rates, instead of increasing their lending rates. This reflects the clear bias of banks against depositors.

The Discussion Paper on the Savings Bank Deposit Rate is showing no signs of life. Pending the comprehensive Discussion Paper, the least the RBI could do, in the present situation, is to immediately increase the Savings Bank Deposit rate from a fixed rate of 3.5 per cent to a fixed rate of 4.0 per cent.

It is unconscionable that banks should borrow from the RBI and place these funds with mutual funds. Banks should not be allowed to pass on their funds management duties to mutual funds.If the RBI is committed to developing the gilt-edged securities market it should progressively increase the proportion of banks' holdings of these securities which should be marked-to-market.

The draft guidelines for licensing of new private sector banks have been inordinately delayed and the RBI would be well advised to release these draft guidelines on May 3, 2011.

(The author is an economist. blfeedback@thehindu.co.in )

Published on June 02, 2011

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