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Reddy swaps growth for inflation

The central bank raised its key short term lending rate, for the second time in less than two months, and ordered banks to hold more cash in reserves. Gaurav Choudhury reports.

business Updated: Jul 29, 2008 21:07 IST
Gaurav Choudhury

With the government left with fewer options to check spiralling inflation, the Reserve Bank of India on Tuesday turned more hawkish, giving price management precedence over growth imperatives.

The central bank raised its key short term lending rate — for the second time in less than two months — and ordered banks to hold more cash in reserves.

“Our internal analysis indicates that barring any further shocks globally, the headline inflation for the next few months will be around the current levels. It should start moderating from the second half of third quarter of the current year,”
Governor YV Reddy said.

Inflation has remained close to a worrisome 12 per cent during the past few weeks, despite a slew of supply-boosting measures from the government and continuous monetary tightening by the Reserve Bank.

The RBI has hiked the cash reserve ratio (CRR)—the mandatory proportion of money banks have to park with the central bank—12 times or four percentage points since December 2006 to suck out excess liquidity from the system.

With the latest hike effective from next month, CRR would stand at 9.0 per cent. The repo rate, the cost of short term loans banks take from RBI, has been increased thrice since March 2007 and now stands at 9 per cent.

Analysts said RBI has maintained its firmly hawkish stance, but the measures would affect growth. “It is clearly evident that RBI is willing to sacrifice growth to contain inflation,” said Rana Kapoor, managing director, Yes Bank.

The central bank acknowledged that growth would be affected, albeit with a time lag. For the current fiscal year, it revised its GDP growth forecast down to 8 per cent or less, indicating the economic slowdown might be getting worse.

The Indian economy has grown by over 9 per cent in the last three years, but the momentum has been hurt since the RBI's monetary tightening extended though this year.

Naresh Takkar, managing director of credit rating and consulting firm ICRA said the latest round of rate hikes were “more severe” than expected. “A slowdown is already visible in many sectors,” he said.

The spectre of an industrial slowdown is looming large with factory output registering a meagre 3.8 per cent growth in May.

“Increased input costs as well as high cost of funds on account of the earlier monetary tightening measures have already begun to erode margins as indicated in the first quarter results of some of the companies,” said Yashika Singh, head (economic analysis), Dun & Bradstreet India, a global consulting firm.

The government defended the central bank's latest move. “The measures taken by RBI today will help in moderating and containing inflation,” a finance ministry statement said, while underscoring the need to moderate credit growth.

“If requests for loans are carefully appraised and credit is allocated prudently, it is possible for the banks to ensure that adequate credit is available to the productive sectors.”