Strong diagnosis, weak prescription

The Mid-Quarter Monetary Policy Review of the Reserve Bank of India shows that it may be succumbing to an inflexible faith in the role it is meant to play rather than in the cold logic of a complex reality and the colder evidence of the results of its previous actions. When it raised the repo rate by 25 basis points to 7.5 per cent, it followed its script faithfully; inflation, it said, “persists at uncomfortable levels”. Headline numbers, it stressed, “understate the pressures because fuel prices have yet to reflect global crude oil prices.”

From the RBI's viewpoint, the logic of its actions appears unarguable. Monetary policy is an effective instrument of inflation control. Students, TV commentators and research analysts believe so. But some feel that domestic inflation originates not in excess liquidity or overheated demand, but in supply shortages unaffected by monetary policy changes. The fact that food prices are still at high levels and that manufactured goods prices have climbed a percentage point in May from 6.3 per cent the previous month, shows that the RBI's actions over the last nine months have not succeeded. Leave alone food prices, non-food prices have remained above the targeted level of 4.5 per cent. To a large extent, global commodity prices have added to the spike in prices, but so have interest rates, that have virtually doubled in the 15 months since the RBI began its tight money policy.

Inadvertently, the RBI's rate hikes, along with food and commodity prices, may have contributed to sustaining non-food prices at higher levels. Yet, mindful of its script, the central bank avers “some short-run deceleration in growth may be unavoidable in bringing inflation under control.” In nine attempts, the central bank has failed; it might pass off that failure on “transmission problems” but the manufacturing sector has felt the pinch. At this point, the relevant issue is not whether growth is moderating, but whether inflation is; so far, the verdict is no. But even more significant is the absence of any action from New Delhi from pledging its armoury of fiscal and public policy measures to ease supply constraints and, thereby, control input prices. The RBI's Mid-Quarter Review is strong on diagnostics, but weak in its prescriptions. The principal cause for this weakness lies in the abysmal lack of actions by New Delhi against the systemic weaknesses of the economy. In that sense, the Mid-Quarter Review is a document not just of the central bank's limited effectiveness but of New Delhi's wilful failure to lend a helping hand.

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