The first quarter review of the RBI’s monetary and credit policy for 2006-07 has answered one critical question. For the first time, the central bank has said it is following a policy of ‘inflation targeting’ — using monetary management to keep inflation within a specified range. Though this had become implicit following the series of hikes in short-term rates over the past few years, the RBI has revealed the target for the first time. Inflation will be kept in the 5-5.5 per cent range for the year, so long as growth stays between 7.5 and 8 per cent. This is also the clearest signal yet of the increasingly globalised nature of the Indian economy. The RBI’s moves have been in tandem with central banks around the world, which have all been been steadily hiking interest rates. The US Federal Reserve has carried out as many as 17 increases in the last three years. Therefore, to dub RBI Governor Y.V. Reddy as an “inflation hawk” for raising rates, with the potential risk of slowing down growth by increasing the cost of capital, would be unfair. Given local and global pressures, he has done the best he could.
But this does not mean there are no worries on the economic or monetary fronts. The RBI, like any central bank, can only manage factors within its control. If there is too much money in the system, it can suck it out. If the economy needs additional funds to fuel growth, it can, within limits, meet such needs. What it cannot do is formulate or implement policies that are under the government’s control. The RBI governor can only warn, as he has done repeatedly, that rising energy costs need to be passed through to the economy more effectively — he cannot order the government to do so. The oil subsidy bill is rapidly reaching critical levels — latest figure is over Rs 92,000 crore. So far, strong industrial growth and buoyant tax collections have helped keep the inflation monster at bay. But one deficient monsoon — and the current one is already showing worrying signs of being agriculturally deficient — or a deterioration in the already fragile situation in the Middle East — could upset all calculations.