Reddy, get set, go for higher rates
Tighten belts all around to lower prices. At the same time, the government need to address shortages on war-footing.india Updated: Jun 25, 2008 21:36 IST
Rattled by the 13-year high surge in inflation to 11.05 per cent, the Reserve Bank of India (RBI) has announced a fresh set of monetary measures to cool down prices. These measures represent the “first line of defence on inflation”, according to finance secretary D. Subbarao. These include raising the cash reserve ratio (CRR) or the amount of cash that commercial banks park with the RBI and the repo rate, which is the rate at which the central bank injects liquidity into the system. This double whammy drains liquidity out of the system and clears the decks for higher lending rates for industry and households. So, this is bad news for home loan borrowers, among others, who will have to fork out larger equated monthly instalments. This is also bad news for the GDP growth, as it will slow it down as a sacrifice for lowering the price rise to more comfortable levels.
How efficacious is this line of defence? This is a pressing question for the government that is forced on the defensive every week with soaring inflation numbers. The RBI’s measures are intended to curb aggregate demand on an economy-wide basis: investment, consumption and also government expenditures. In this regard, it has drawn attention to ‘fiscal pressures’ due to enhanced subsidies on account of food, fertiliser and petroleum. The efficacy of the RBI’s policies clearly is predicated on their success in curbing such demand. The upshot is that without belt-tightening by industry, households and government, these measures are unlikely to bring down inflation on a sustainable basis.
The government also has a major role to play in supply-side management. The battle against rising prices, especially of food, cannot be won unless conditions improve in Indian agriculture. Greater vigilance is necessary to check inflationary expectations. Although the monsoon has arrived, the seasonal decline in food prices has not yet set in. There is a shortage of fertilisers and sowing operations have been delayed. The government must address such shortages on a war-footing.