|In the first quarter review of the annual monetary policy, RBI increased the CRR by 0.50 percentage points and increased the repo rate by 0.25 percentage points. Both these instruments were used as measures to control inflation through control of money supply and aggregate demand. RBI has used these instruments in past also, but this year the increase has been rather gradual.
|Keynes advocated the use of anti-inflationary monetary policy under a full employment framework. But such interventions are not best suited for India due to existence of disguised unemployment and also large part of the economy (agricultural sector) is non monetised. In such a scenario, monetary policy can only play a secondary role and alone may not be able to generate intended results. Past trends indicate that in India inflation is not a temporary phenomenon and monetary policy tools alone, may not keep inflation down or stabilise it for too long. RBI has defined the comfort zone for inflation to be around 5-5.5%. Looking at the quarterly inflation figures since 1999, this mark has been frequently crossed with major peaks in 2000, 2003, 2004, and 2007 and yet again in 2008.
|A tight monetary regime do effect inflation but in phased manner. The first effect is felt instantaneously while the second is felt with a lag of 6 to 8 months. With such a persistent inflationary trend, the correlation coefficient between CRR and the rate of inflation is (-) 0.55, clearly implying a moderate level of interdependence between the two over the past decade. Apart from this, in developing economies, there is an increasing need for credit to feed engine of growth. Thus restricting credit hampers capacity building mostly in the sensitive sectors of the economy. Using the CRR route to curtail excess credit may not have similar impact for all sectors and industry groups. It does however restrain credit only in the more vulnerable sectors while the bigger firms have access to funds via other sources like retained earnings, capital markets and other external sources. Further, a increase in CRR affects domestic consumption and also impacts the aggregate demand component by affecting investment in the economy. This would in turn have an effect on capital formation, productivity and on future supply, aggravating the situation further. Thus it creates a vicious circle for inflation. In the second quarter of 2008, when the CRR was raised to 8.5%, the rate of growth of private sector credit came down from 8.5% (approx.) in the first quarter to 1.8% by the end of May in the second quarter. Also, for the agricultural (and allied activities) sector, the year on year variation in the debt outstanding as on May�08 was 19.3% as compared to 32.3% as on May 07. Thus we see that credit control may not be the single most effective policy instrument; it neess to be supported by other measures, especially measures to smoothen supply of commodities. A study by RBI shows that 74% of the current inflation is supply driven. Restricting credit has an effect on domestic demand, while in the present situation; it is mostly the rise in global demand that is leading to a mismatch in demand and supply. Measures should be undertaken to improve the supply situation rather than to limit the domestic demand.
Monetary Policy is but one tool to curtail inflation. As an economy experiences inflationary situations, appropriate and timely use of the monetary policy can provide some immediate relief, in the short run. But, there is also an important role for the fiscal policy. In order to stabilise inflation in the medium and long run, resources must be prudently diverted towards building up the supply capacity in the economy, and particularly in the more vulnerable sectors of the economy. For that purpose, monetary policy instruments may be complemented with fiscal policy efforts directed towards strengthening the supply in weaker sectors of the economy, for instance the agriculture sector. Large part of this sector is rain fed and hence efforts to overcome such constraints may be undertaken. A great proportion of the current inflation is triggered by food crises, apart from the rise in petroleum, steel and cement prices. Higher actual public investment needs to be undertaken to overcome the supply bottlenecks in this important sector of the economy. RBI has been doing its bit, rather frequently, but monetary policies work the best when complemented by prudential fiscal policies.
|TANU M. GOYAL