Focusing on Inflation

Focusing monetatry policy on taming recalcitrant inflation, the Reserve Bank of India has raised its policy interest rates for the 13th time since March 2010. While the impact of the past monetary policy actions on prices is yet to unfold, its deleterious effect on growth is quite evident in the downward revision of the gross domestic product for the fiscal to 7.6% from 8% earlier. According to official analysis, Asia’s third largest economy continues to be exposed to high inflation risk, due to structural imbalances in agriculture, infrastructure bottlenecks, a fiscal deficit as also the public debt overhang. This would inevitably result in a continuing squeeze on the living standards of people.

According to theoretical formulations, other factors remaining the same, an increase in real output lowers the price level and an increase in money supply raises the price level. Now one of the major factors influencing money supply growth is deficit financing or net Reserve Bank of India credit to the government. The deficit and the public debt of the Government of India have been rising over the years with no corresponding impact on investment and production. The resultant financial leakages go to strengthen the parallel economy. It is only when the two blades of the policy scissor, namely, monetary and fiscal policies are sharp and functional, will the objective of policy be achieved. There is a limit to which monetary policy alone can accomplish things. If inflation is triggered by higher oil and commodity prices, and a high fiscal deficit, how can a rate rise influence prices to any meaningful extent? If monetary policy acts with a lag, or produces results with one, why should the monetary authorities tinker with interest rates at every monetary review? What prevents the RBI from using other credit policy measures? Perhaps it is time to look at the central bank’s armoury and see if policy instruments like a quantitative credit ceiling or qualitative methods like selective credit control, etc, have any relevance in the present context.