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Dial RBI for Missed Numbers!
From Inflation to Liquidity Deficit, The Fiscal gone by has seen RBI missing on many Projections; still, The New Monetary Policy has Proposed high hopes. But Considering that India at Present is Living a trade off between growth and inflation, RBI needs to be more Serious and Realistic in its Approach.
Issue Date - 26/05/2011
For the past 18 months or so, India has been at the crossroads Ė unable to decide whether to control the inflation menace at the cost of growth or concentrate on a double-digit growth allowing inflation to take its natural course. Perhaps, that is the reason for which, we have only RBI fighting against inflation through its monetary policy measures. But what is hilarious is the performance of statisticians at the RBI headquarters. Because of them, the RBI is even more confused as to how far and how fast it should move to control inflation.

Amidst a high inflation rate of over 9% prevailing all throughout the last 12 months, perhaps, few must still be remembering RBIís annual policy statement in 2010. With great amount of determination, the apex bank targeted to bring down inflation to as low as 5.5%. But after 5 rate hikes of 25 basis points each between April and November, the RBI finally realised that they are heading nowhere. So, by January the inflation target was revised to 7% and then to 8% in March, yet it was wide off the mark as WPI in March climbed 8.98% and this provisional figure, when revised, could get close to 10%. After the disastrous predictions in the last fiscal, in the Monetary Policy announced for financial year 2011-12, RBI has now pegged inflation at 6% with an upward bias. But, considering the increasing pressure on commodities in the country due to supply side crunch in particular and the instability in global crude prices, a revision of this target may soon become necessary despite RBIís bold 50 basis point hike in repo and reverse repo rates early this month (eighth consecutive rate hike in less than 13 months).

But itís not only on the inflation front that the RBI economists have floundered. RBI was also found in soup in case of liquidity management in the system. The bankís measures to control liquidity was certainly in line with its measures to combat inflation till liquidity deficit shot up to unparallel levels. While RBIís comfort zone is plus/minus 1% of net demand and time liabilities (NDTL) or Rs.500 billion, in the second half of the fiscal liquidity deficit climbed up to as high as Rs.1,700 billion and the deficit remained over double the RBI estimate for a good part of the second half of the last fiscal. So much so that the RBI had to undertake open market operations (OMOs) and other measures in the third quarter to ease liquidity pressure. In total, RBI had to purchase government securities of Rs.670 billion to control the situation till the government started increasing its spending in the last quarter.

But the question remains, why could the RBI economists not see this coming? Were they expecting this liquidity crunch to take care of inflation by anyway and it was just about to be proven as a fatal hope than a well calculated risk? The second seems to be more appropriate, at least for the way RBI kick started a number of measures to mitigate the liquidity deficit in the last quarter including reduction in the statutory liquidity ratio (SLR) from 25% of NDTL to 24% with effect from December 2010, and additional liquidity support to scheduled commercial banks (SCBs) under the liquidity adjustment facility (LAF, this facility, which was initially available upto 2% of NDTL, was brought down to 1% after reduction the SLR by one percentage point). In fact, the average daily net liquidity injection through LAF was at around Rs.1200 billion during December 2010 (Rs.900 billion in January 2011).

However, with the government increasing its spending in the end months, RBI now looks at a little more ease than where it was in the beginning of 2011. But then, that can neither hide the RBIís missed targets on account of credit-deposit growth gap (estimated to be 2%, but actual ended up at 4.6%) or money supply (16% actual compared to 17% estimataion) for that matter, nor can it save the apex bank from the awkward situation that it may face for not bringing out guidelines for the entry of new banks and road-maps for foreign banks in India, which were long due.

In the meantime, in its policy statement for the ongoing financial year, RBI has again put forward a strong target to control inflation to 6% by the end of this fiscal as compared to forecasts of 7% to 7.5% put forward by most of the industry analysts. In fact, the IMF expects the same to be just about 7% by the end of the fiscal, clearly indicating that RBI is again eyeing for a big target to achieve. There is no doubt that without much support from the government, in terms of removing supply side bottlenecks to control inflation, RBI, with its monetary policies, has been fighting to curb inflation. But then, rather than being over ambitious and giving rise to a series of new problems on its way, the economists at the apex bank need to be more realistic in there approach while forecasting the future course and opt for policies and strategies that are achievable.

Moreover, taking a clue from what D. Subbarao, Governor, RBI had said in a recent media interview Ė ďThe baby step approach was good for last yearís growth-inflation dynamics. The dynamics have changed now...Ē Ė it is quite clear that the central bank is more determined to bring inflation to order irrespective of how strict a measure it needs to take. For that matter, the recent 50 basis point hike in repo rate and reverse repo, as against 25 basis points expected by the industry, can be considered as a hint for the things to follow. In such a case, it becomes all the more imperative for the brains at the RBI headquarters, who wants to graduate to measures that can be called bigger than baby steps, to ensure that every step is taken in the right direction. Because with such sharp action, the repercussions are even more sharper. Passing a rectification entry may be easy with baby steps, but for these leaps, well, they just cannot afford to allow any damage to the system, at least not at a time when RBI is moving ahead with an operation to curb inflation at the cost of growth.

Mona Mehta           

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