In its Monetary Policy Statement for 2011-12, the Reserve Bank of India has come out boldly and decisively in its battle against raging inflation. For the first time over the past one year, inflation control has received precedence over growth. With inflation showing no signs of abating, the RBI now seems reconciled to sacrifice some growth in the short run. It is now for the government to take the RBI's cue.

Earlier, many commentators had said that the RBI continues to remain behind the curve in raising its policy rates by 25 basis points at a time even as inflation continued to surge ahead.

Admitting that headline and core inflation have overshot even the most pessimistic projections over the past few months, the RBI has now opted for a decisive change in stance, according top priority to inflation control.

According to RBI Governor Dr. D. Subbarao, the monetary policy trajectory that is being initiated is based on the following basic premise: Over the long run, high inflation is inimical to growth as it harms investment by creating uncertainty.

MONETARY MEASURES

Announcing the changes in the operating procedure of monetary policy, the central bank has stated that henceforth there will be only one independently varying policy rate, and that will be the repo rate.

This has been done to more accurately signal the monetary policy stance. The reverse repo rate will be automatically pegged at 100 basis points below the repo rate.

Also, a new Marginal Standing Facility (MSF) has been introduced. Banks will be able to borrow overnight from the MSF up to 1 per cent of their respective net demand and time liabilities (NDTL) at an interest rate that will be 100 basis points above the repo rate. This is intended to ensure that the banks do not face any sudden liquidity crisis.

The repo rate has now been raised by 50 basis points from 6.75 per cent to 7.25 per cent. In a more significant change, it has been decided to raise the interest rate on savings deposits from the prevailing 3.5 per cent to 4.0 per cent with immediate effect. This could be interpreted as a precursor to deregulating this rate in the coming days. This rate had remained unchanged since March 2003 even as the real interest rate turned negative by a big margin because of the high rate of inflation.

Because of high oil and other commodity prices and the impact of the anti-inflationary monetary stance, the RBI expects the real GDP growth during 2011-12 to moderate to around 8 per cent from the estimated 8.6 per cent in 2010-11.

With regard to the WPI-based inflation, the RBI expects it to remain at an elevated level in the first half of the year, before gradually moderating to six per cent by March 2012 with an upside bias.

Persistence of high international crude prices as also the prices of other commodities could keep the inflation rate at a much higher level. Moreover, the rate hike of 50 basis points and the increase in the savings bank will increase the cost of funds of the banking sector. This, in turn, will force the banks to raise their lending and also the deposit rates.

FISCAL DISCIPLINE

For ensuring the efficacy of the aggressive monetary policy stance , there is a need for complementary action by the Finance Ministry aimed at fiscal consolidation. Unfortunately, the Centre's fiscal situation continues to remain worrisome.

To add to the problem, the fiscal consolidation process that was witnessed in most States during the four years from 2004-05, has taken a turn for the worse during the past couple of years with economic slowdown following the financial crisis. The problem was further accentuated with the implementation of new pay scales recommended by the Sixth Pay Commission.

The surging crude oil prices have seen the subsidies on petroleum products zoom to unprecedented levels.

At current prices, the oil marketing companies (OMCs) have been losing about Rs18.19 a litre on diesel, Rs29.69 a litre on PDS kerosene and Rs329.73 per LPG cylinder of 14.2 kg. The OMC's losses are estimated at Rs1,80,208 crore during the current fiscal. Not surprisingly, the RBI has recommended an immediate hike in fuel prices.

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