Monetary Policy: RBI’s tightrope walk

RBI, in its constant effort to fight inflation, might thus push the repo rate to 6.75 percent from 6.5 percent and reverse repo rate to 5.75 percent from 5.5 percent.

Updated: Mar 15, 2011, 17:25 PM IST

Reema Sharma

The Reserve Bank of India (RBI) is coming out with its Third Quarter Review of the Monetary Policy on March 17. RBI has already raised key policy rates seven times in a year from March, 2010. Experts believe that RBI this time too is all set to increase its key lending and borrowing rates.

Economists and experts expect RBI to raise the repo and reverse repo rates by at least 25 basis points. RBI, in its constant effort to fight inflation, might thus push the repo rate to 6.75 percent from 6.5 percent and reverse repo rate to 5.75 percent from 5.5 percent.

RBI’s Deputy Governor Subir Gokarn has already expressed concerns over high oil prices and indicated that it would put pressure on the RBI`s strategy to manage inflation.
Finance Minister Pranab Mukherjee has also time and again admitted that inflation had continued to be challenging and added that the moderation was too small to be comfortable.

Therefore, the most intriguing fact remains the same. Previous seven rate hikes have not helped the economy in a great deal in its fight to contain inflation. Although food inflation after a gap of nearly three months fell to a single digit at 9.52 percent for the week ended February 26, economists believe that headline inflation still remains sticky.

Market specialists also believe that headline inflation is likely to remain above RBI’s comfort level until March-end.

Moderating marginally from December`s 8.43%, headline inflation in January was at 8.23 percent. It stood at 8.53% in the same month last year.

If the government’s decision to deregulate diesel prices is to be believed, inflation is bound to be unbridled. RBI and the government can’t deny that these factors would not reflect in the Wholesale Price Index (WPI) inflation for March.
Added to that, high crude oil prices, widening current account gap and geopolitical uncertainty are continuously haunting the Indian economy.

RBI must keep in mind India’s current account gap which widened to 3.7 percent of gross domestic product (GDP) in the first six months of this financial year. Ever since 1991, it was the first time that the current account deficit expanded to over 3 percent.

But a few positive indications have been signalled by export and import sector. India`s exports showed some signs of relief with 49.8 percent year-on-year growth in February. Export grew to USD 23.6 billion in February fuelled by increased demand from markets like North America, Asia and Africa. Imports also went up in February, rising by 21.2 percent to USD 31.7 billion.

However, an encouraging export and import data can be marred by India`s infrastructure sector growth which slowed down to a meagre 3.7 percent during January. The sector, which had expanded by a robust growth of 57.9 percent in January, 2010, upset Planning Commission Deputy Chairman Montek Singh Ahluwalia. Disappointed with the IIP growth, Montek said that the overall slowdown for the last 2-3 months was a matter of concern.

With the monetary policy trajectory expected to tighten, all eyes are now on the Reserve Bank of India. Hope that RBI can answer the questions about Indian economy`s ability to grow by 9 percent without prompting spiraling inflation.