The Reserve Bank of India's Report on Macroeconomic and Monetary Developments (January 24, 2011) and the Monetary Policy (January 25, 2011) provide a competent and perceptive analysis. The reports clearly bring out that inflation is intolerably high. There are signals that while the real rate of growth in 2010-11 would be around 8.5 per cent, the growth rate could be somewhat lower in 2011-12.
EXTERNAL SECTOR
The external sector, which for many years showed strength, is now showing signs of wilting. The balance of payments current account deficit (CAD) in 2010-11 is projected at 3.5 per cent of GDP — eventually, it could be even higher at 4 per cent of GDP, which would make foreign investors a tad nervous, and unless corrected could trigger a loss of international confidence.
While capital inflows have been adequate, there are concerns that foreign direct investment (FDI) has shown a sharp dip in 2010-11, and while portfolio flows have been higher, they are volatile.
At the end of September 2010, the ratio of forex reserves to total foreign debt is 99 per cent — the lowest in many years. The ratio of short-term debt to total debt (on a residual maturity basis) is uncomfortably high at 43 per cent. The import cover of reserves (in terms of months) has fallen to 10.3 months after many years when it was over 12 months. The vulnerability of external sector indicators calls for a critical review.
RUNAWAY PRICE RISE
The RBI documents are replete with anxiety over inflation, which was earlier restricted to a few select items, but is now all-pervasive. The Wholesale Price Index (WPI), on a year-on-year basis, shows an increase of 8.4 per cent. Food inflation of 13.5 per cent is unacceptable. Even though the weightage for food articles and food products in the WPI is only 24.3 per cent, family budget data would indicate that the proportion of food items is much higher, and that the masses are hit by even higher inflation.
What is distressing is that both the government and the RBI seem to have thrown up their hands on controlling inflation, even though inflation has now become generalised.
The RBI has rightly cautioned the government on the need to swiftly undertake fiscal consolidation. At the same time, the central bank cannot renege on its dharma of controlling inflation. The general sense of helplessness regarding the inability to control inflation is worrisome. The RBI's impeccable analysis points to the need for strong action to control inflation, but unfortunately there is a great divide between analysis and policy.
The genie of inflation is now fully out of the bottle and it is going to be increasingly difficult to get it back in. The experience the world over is that moderate inflation easily degenerates into uncontrollable inflation. Timidity in using monetary measures to curb inflation on the premise that it could affect growth is a false start. Delays in controlling inflation would invite harsher measures which would inevitably affect growth. With inflation out of control social tensions can explode and totally abort growth.
The RBI in its best judgment — which one respects — has been raising the policy interest rate by 0.25 percentage points at each stage and in December 2010 even gave this minuscule increase a miss.
LOOSE MONETARY POLICY
The signals are loud and clear. The present repo rate of 6.5 per cent is totally out of sync with the current inflation rate of 8.4 per cent. The continuation of negative policy rates of interest cannot but have adverse effects on the economy. Deposit growth lags far behind credit growth and it is no surprise that the incremental credit-deposit ratio for the latest 12-month period is well over 100 per cent, which is clearly unsustainable.
Superimposed on very low policy interest rates is the massive quantitative easing by way of large access to the repo window, large open market purchases and the reduction of the statutory liquidity ratio.
Since the RBI stands ready to bridge the liquidity gap at very low rates of interest, the more it pumps in liquidity, the higher the credit-deposit ratio, which is followed by tight liquidity which, in turn, is addressed by further RBI easing — such a vicious circle can only end in policy chaos with prudent monetary policy going for a toss. It is imperative that the RBI reconsiders its permissive monetary policy stance.
Hosannas will be sung for the latest monetary policy which will please those that matter. The flip side is that the masses will suffer the cruel burden of inflation.
The choice before the RBI is to undertake the right policies of crushing inflation irrespective of the criticism it would have to face, or be condemned by history for inflicting inflation on the masses.
(The author is an economist. >blfeedback @thehindu.co.in )