Keeping the primary objective of controlling intolerably high levels of inflation in mind, The Reserve Bank of India (RBI) has hiked cash reserve ratio (CRR) by 25 basis points (100 basis points = 1 percentage point) and repo rate (the interest rate at which RBI lends to commercial banks) by 50 basis points.
Despite a tight liquidity scenario, the hike in both rates indicates that the central bank wants to send out clear signals to all investors—retailers as well as institutional investors—that the structural strength of our economy is the prime concern for the government.
A hike in CRR will suck out liquidity from the system, which is already running at tight levels. This will impact the common man in two ways: there could be negative impact due to increase in lending rates on credit, while increase in deposit rates will create a positive sentiment. This will result in further tightening the money supply in the economy, which is currently adding to the inflationary pressure.
Though current levels of over 11 per cent inflation are very high, the true picture seems to be gloomier. There has been no revision in certain items in WPI since the beginning of this year, which adds to the fact that inflationary pressure could be higher than what is shared currently. Hence RBI’s current aggressive stance seems to be in the right direction.
We need to understand that policy measures are meant to deal with structural factors driving developments like high
inflation. Such high levels of inflation impact the balance sheet of the government and increase vulnerability of the economy. This in turn impacts the sentiment thereby affecting market performance.
Though RBI’s stance has dampened the market sentiments, investors need to understand that it is important to ensure price stability. Current levels of high inflation are a mix of domestic as well as international factors.
On the global level oil prices are rising, increasing inflation is casting serious concerns and growth figures are softening. In view of the evolving environment of heightened uncertainty in global markets and the dangers of potential spillovers to domestic markets, liquidity management is bound to be high on the central bank’s agenda.
Slowdown in advanced nations is becoming broad-based and hence “heightened” vigil on domestic macro developments is required to ensure swift policy response to contain any uncertainty emerging due inflationary pressure.
Thus overall what we believe is that in the near term such an aggressive policy stance may create some pains but in the long term, they will contribute substantially to strengthen the Indian economy.
(Nilesh Shah is the Deputy MD, ICICI Prudential AMC)