Cleft stick PDF Print E-mail
Tuesday, 25 January 2011 00:00
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When I meet other central bankers, RBI governor Duvvuri Subbarao recently said, “they tell me why don’t you give us a bit of your inflation so that our growth will be faster. That’s how desperately they want some inflation and how desperate we are to control our own inflation.” That illustrates the cleft stick the government is caught in, before RBI’s Q3 policy review. In its earlier review, RBI was categorical that the possibility of further rate hikes was low in the immediate future. That was predicated on inflation slowing down, but this didn’t happen and the base effect is wearing off beyond January 2011. In November, the point-to-point WPI showed an increase of 7.5%, not too comfortable, but low enough for RBI to postpone the thought of hikes in policy rates. The point-to-point WPI hike was a higher 8.5% in December, making the target of 5.5% impossible to achieve—even the new 6% target looks impossible. While both the food (15.52%) and primary articles (17.03%) numbers are today lower than they were in comparable periods in January 2010, they are inordinately high and those for fuel and power have increased. Inflation is being driven by primary articles and fuel and power, less so manufactured products, as an FE study of production data and price hikes showed—but even in the case of manufactured products, increases in input costs are now leading to price increases.


That monetary policy is singularly ineffective in dealing with such inflation has been publicly acknowledged by Chief Economic Advisor as well as by others. But the government cannot be seen to be doing nothing about inflation and there has been a near-complete failure to address supply-side issues on farm products. Which is why even the head of the PM’s Economic Advisory Council has asked for a rate hike. Thus, a rate hike is certain and markets have factored it in. The moot point is the extent of the hike and what it does to growth. The first half of 2010-11 has seen a growth of 8.9%, and while government spokespersons have talked of it touching 9% for the year, the IIP shows clear signs of slowing—results of some capital goods firms like L&T also show a higher rate of orders being cancelled. The impact of a rate hike will show in growth declining to 8% in 2011-12. The extent to which this slowdown is acceptable will be reflected in whether policy rates are hiked by 0.25% or 0.50%. Unfortunately, nothing will happen to inflation, but growth will slow down. Since it is concerned with liquidity and slow credit growth, RBI might also reduce the CRR and SLR.


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