Policy Tilts to Anchor Inflation Expectations

The Annual Monetary Policy Statement (including Developmental and Regulatory Policies) for 2010-11 announced by Reserve Bank of India (RBI) Governor D Subbarao on 20 April was in the first instance a bit disappointing for while it contained the basic background to the policy and monetary measures effected in the annual statement, a discussion of key monetary policy issues was largely absent. The RBI governor did, however, express his views on a number of critical issues at the Peterson Institute for International Economics, a few days later on 26 April 2010 soon after the spring meetings of the International Monetary Fund and the World Bank. Therefore, for a comprehensive understanding of all related issues, the annual statement should ideally be read together with the speech at Washington.

The annual policy clearly emphasises the change in policy stance to “anchor inflation expectations” departing from the 2009-10 statement when the priority was “to enable credit expansion at viable rates… so as to support the return of the economy to a high growth path”. Of course, during the course of the last financial year, the tilt in balance from managing the crisis to managing the recovery commenced in October 2009 when the early signs of pickup in economic activity were visible and the inflationary build-up was also foreseen. The upward revisions in policy rates (repo and reverse repo) and also the cash reserve ratio (CRR) – all by 25 basis points – announced in the monetary policy statement had been anticipated and discounted by the market. The serious downside risk now is on the inflation front. Inflation, earlier driven mostly from the supply side is now getting increasingly generalised. First, the prospects for the 2010 monsoon are not yet clear. Second, crude prices continue to be volatile. Third, there is evidence of demand-side pressures building up. On balance, the baseline projection for inflation as measured by the wholesale price index (WPI) for March 2011 is placed at 5.5% against 9.9% for March 2010. A reduction in the inflation rate by 4.4 percentage points seems to be a Herculean task. Furthermore, the medium-term objective of 3.0% inflation would require, apart from calibrated monetary measures, significant improvements in supply-side management. That would be possible only with a stronger involvement of the fisc. Given all these factors, it appears that the RBI is behind the curve at this juncture.