True to form, the Reserve Bank of India's Monetary Policy Statement for fiscal 2011-12, like its predecessors, documents the economy's trajectory thus far, complete with all its warts and moles. Where it may have erred is in the prescriptive treatment of a fresh dose of tightening up of credit that leaves something to be desired. What makes it all the more unfortunate is that the RBI had in its possession far superior data than was available to the Government at the time of presentation of the Budget or the Economic Survey.
The RBI has quite rightly identified that inflation, this time around, is stoked by a boom in global commodity prices. It has talked of a growing “pricing power” of producers that stems from a demand situation that is “strong enough to allow significant pass-through of input price increases.” Equally, the RBI also acknowledges that this is happening despite “visible signs of moderating growth…” — of all the places, in capital goods production and investment spending, for which the central bank immodestly pats itself on the back. To take credit for tightening interest rates to the point that investment spending and the capital goods sector decline is to admit to stifling the engines of capacity creation in core sectors of the economy. This is at a time when the sector is in need of additional funding to shore up capacity and secure higher output in the process. Yet the RBI has raised the repo rate significantly higher, by 50 basis points, whereas so far it had routinely raised it by half that number. The problem doesn't seem to lie in just the core sectors alone. The policy also tells us that its own two surveys, on industrial outlook and on order-books and inventories, in other words, a far broader spectrum of the economy, point to a far more pessimistic view than earlier. Amidst such overwhelming evidence it has chosen to do what it has on the ground that inflation has to be tackled. This is, of course, an old defence for tightening, even though it has little impact on overall inflation. A tighter monetary regime might have released some speculative pressure in the real estate market but overall, inflation still looms large for reasons beyond the central bank's control. The RBI has nevertheless been cautious in its tightening and left the Bank Rate untouched. It has also introduced a new window for banks with the Marginal Standing Facility (MSF) at which banks can borrow overnight funds up to 1 per cent of their Net Demand and Time Liabilities. By creating an additional window, albeit a small one, of liquidity, the RBI must be hoping that banks' ability to lend to critical sectors will not be constrained by any shortage of resources
The treatment the RBI dishes out for the economy's ills — moderating growth and persistent inflation — may prove ineffective. But its diagnosis of slowing investment spending should provide New Delhi food for thought.