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CREDIT POLICY
A War On Inflation
The RBI’s credit policy review was focused on inflation
SRIKANTH SRINIVAS
01 Feb 2008
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A FIRM STANCE: Prudence has
been the hallmark of Y.V. Reddy’s
policy (AP) |
On 30 september 1979, just before the start of the World Bank/IMF Annual Meetings in Belgrade in the former Yugoslavia, financial leaders from around the world gathered to hear then US Federal Reserve Chairman Arthur Burns deliver a speech that distilled lessons learned from a lifetime in policy-making. His topic: inexorably accelerating inflation.
It was a time of chaos. The dollar had suffered its worst battering in history. Investors were running into gold, real estate, art, even race horses and wine. Countries such as Saudi Arabia and Kuwait told then US President Jimmy Carter that unless the dollar stabilised, they would raise oil prices, and diversify reserves out of that currency. In March that year, the Europeans had announced the formation of the European Monetary System, the precursor to the European Monetary Union (now the euro) to create “an island of stability” for Europe against the effects of a rapidly falling dollar.
Fast forward to 2007-08, and the picture looks surprisingly familiar. Global inflation once again threatens growth prospects of much of the world; in Europe, Australia, New Zealand, and now India, inflation has become the enemy. Finance Minister P. Chidambaram himself pointed out at the World Economic Forum in Davos last week that he would be happy to settle for half a percentage point less in GDP growth, rather than let inflation rear its ugly head In India.
Reserve Bank of India (RBI) Governor Y.V. Reddy underlined that sentiment at his press conference on the Q3 review of the monetary policy for 2007-08 on 29 January. “Yes, he was hawkish on inflation, but that may not have been unwarranted,” says Indranil Pan, chief economist at Kotak Mahindra Bank.
Yes, currently inflation is within the central bank’s comfort zone, but it is inflationary expectations that Reddy is worried about. He focused on that, saying that the RBI’s policy stance would be “to monitor the evolving heightened global risks due to global inflationary pressures, food prices and the injection of huge liquidity into the financial markets”.
His worries are not misplaced.Oil and food prices have been rising globally. The same is true for India, even if price increases are not passed through. “As our economy grows, consumption demand increases, and food prices increase as a consequence, and have,” says Manika Premsingh, economist at Edelweiss Capital, a financial services firm in Mumbai.
Oil imports have risen by about 30 per cent in price terms, but the retail prices of kerosene, petrol, diesel and liquefied petroleum gas have not been raised in almost two years. But it may be beginning to affect corporate profitability. The earnings report from Hindustan Petroleum shows the first signs of forthcoming trouble: the refining company showed a third quarter loss — a small one, but a loss nevertheless — despite higher refining margins and higher sales of its products. The government’s policy of issuing oil bonds to postpone the problem of keeping fuel prices low has not helped the company.
Then there is the problem of capital inflows. Foreign exchange reserves were up about $86 billion for the year 2007-08 through 18 January 2008, coming mainly from net portfolio flows, foreign direct investment, external commercial borrowings and remittances. Even after sterilisation, money supply growth was more than 22 per cent — way outside the RBI’s target of around 17 per cent.
Financial markets were a little disappointed. They were hoping that Reddy would take US Fed Chairman Ben Bernanke’s lead and cut interest rates. But Reddy was clear that the Indian situation did not warrant it. As critics of the Fed’s actions pointed out, the job of a central bank is to preserve price stability, not provide liquidity support for equity markets through cuts in policy interest rates.
Even if the Fed has backed itself into a corner with the US markets expecting another large cut on Wednesday, Reddy has chosen the path of prudence. But he has left himself room for manoeuvre, suggesting that the RBI will not hesitate to cut rates if the situation calls for it before the next policy review.
The policy also made special mention of employment in labour-intensive industries, presumably export-oriented businesses such as textiles and garments. Reddy suggested that bank lending to these sectors should be made a priority. What makes it unusual is that the RBI has usually not focused on employment as part of its monetary policy stance in recent years. Presumably, the appreciation of the rupee vis-à-vis the dollar and the consequent impact on export-oriented industries prompted the central bank to include it as part of this policy review.
In his Belgrade speech, Burns pointed out that the central banker’s independence to fight inflation notwithstanding, in practice there were strong political constraints against raising interest rates. The title of that speech? The Anguish of Central Banking.
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(Businessworld Issue 05 - 11 February 2007) |
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