RBI needs to rethink on monetary tightening

Slow industrial growth and widening fiscal deficit are prompting the policy makers to take a re-look at its policy of monetary tightening to contain rising prices.

Last Updated: Mar 15, 2011, 20:41 PM IST

Ajeet Kumar

RBI mid quarter review on monetary policy is to be unveiled on Thursday. It is widely expected that the central bank may continue its streak of interest rates hike to nail food inflation. But slow industrial growth and widening fiscal deficit are prompting the policy makers to take a re-look at its policy of monetary tightening to contain rising prices.

The Reserve Bank of India (RBI) has already raised its key interest rates seven times since March to contain inflationary pressures. The lending rate known as the repo rate have been increased by a total of 175 basis points and borrowing rate, or reverse repo rate was raised by 225 basis points.

Deceleration in manufacturing and mining sectors pulled down the industrial growth, measured in terms of index of industrial production to a meager 3.7 percent during January as against 16.8 percent in the same month last year. This makes it a daunting task to maintain the expansion momentum during the same period of this fiscal due to the high base effect.

During April-January period of current fiscal, industrial growth slowed to 8.5 percent, from 9.5 percent in the previous financial year.

Industry chamber Ficci has suggested that RBI should avoid increasing the key rates during the mid quarter policy on March 17, as it would affect the industrial output which is already lagging behind.

Manufacturing capacity expansion may not be feasible in the light of rising cost of borrowing and increased competition within domestic market from imports, Ficci said in a note.
Experts are also saying that the manufacturing output is still sluggish and the industrial growth is yet to reflect continuous momentum. Another rate hike by RBI may dampen future growth prospects rather than moderating inflation.

As far as headline inflation is concerned it is still over 8 percent, well above the RBI`s perceived comfort zone of 4-5 percent. And the end-March target is 7 percent.

However, India`s annual food inflation eased to a three-month low of 9.52 percent in late February, as prices of vegetables, potatoes and rice declined, data showed week ended February.

Many analysts are stressing the need to balance between growth and inflation. They are saying that the latter is mostly a supply side problem and the government should try to ease supply bottlenecks and leakages rather than taking monetary steps like increase in interest rates which could only be able to curb demand led inflation.

They add recent inflationary spiral in food prices were seen only due to less supply of crops like onions, garlic, tomatoes and some of the green vegetables. But now constraints in the supply of these commodities have almost eased out and will likely to gain more momentum in the near term.
In their view inflation figures will see more downside pressure in March onwards owing to arrivals of winter sown crops.

Headline inflation may come at around 5-6 percent between April and June as this will be the time when Rabi crops` harvesting will remains at its peak. Expectation of bumper Rabi production might also weigh on prices, they opined.

The Indian government is expecting a bumper production of food grains and pulses this year in wake of a very good monsoon in 2010 that boosted the Kharif crop coupled with some late rains that resulted in good soil moisture for the Rabi crop. Overall, farm production is set to reach close to record-highs, according to the latest estimates released by the farm ministry.

Production of wheat is estimated to reach an all-time high of 81.47 million tonne. Even more important is the case of pulses output which is all set to cross the 16-million-tonne-mark for the first time to reach 16.51 million tonne.

Similarly, in case of maize too the production is set to sour to 20.03 million tonne. Overall food grain output is expected to rise to 232.07 million tonne this year, marginally below the record production of 234.47 million tonne seen in 2008-09.

But some experts are still saying that the policy makers should remain cautious till the inflationary conditions are reversed in India and normalcy is restored in the developed economies.

They maintain that besides supply bottlenecks and the prospects of high crude-prices, concerns over robust credit growth and elevated levels of non-food manufacturing inflation are likely to prompt central bank action to curb demand-led inflation.