Perspective: Has RBI left growth to fend for itself?

The Reserve Bank of India's (RBI) anti-inflationary stance, adopted a little over two years ago, is still in effect. That is the message from Mint Street, which on Monday kept the policy rates unchanged in its mid-term monetary policy review, despite mounting concerns over falling growth of the economy.

The economic growth, measured by change in gross domestic product (GDP), has become a casualty with fourth quarter (Jan-March) of 2011-12 figures plunging to 5.3 per cent. In 2011-12, GDP growth fell to 6.5 per cent.

In the last two years, RBI has hiked policy rates by nearly 400 basis points. While the rate hikes of the last two years failed to tame inflation, slowing growth is emerging as a much bigger concern than inflation.

Has RBI left the growth to fend for itself?

Just two months ago, the repo rate - the rate at which banks borrow funds from RBI - was reduced for the first time since March 2010 by a surprise 50 basis points.

The status quo in policy rates actually stems from the past history of high and volatile inflation rates since independence.

According to RBI statistics, inflation, as measured through the wholesale price index (WPI), was quite volatile throughout the 1950s, 1960s and 1970s. In later years, the volatility reduced a bit but the memory of double digit rates haunted the country.

The longest period of consistent double digit inflation was nearly three years, from October 1972 to March 1975, when crude oil prices wrought havoc with the economies of the world.



That period was followed by another shock in the mid-90s when the inflation rate remained in the double digits for 15 months, between March 1994 and May 1995.

The possibility of inflationary pressure revisiting the market still hovers over the system.

For instance, take the impact of the recent petrol hike. In order to keep the subsidy under control, the government has to bite the bullet when it comes to diesel and LPG price hikes.

Headline inflation, commonly measured using the WPI, stood at 10.36 per cent in March 2010, fell marginally to 9.44 per cent a year later. It now stands at 7.55 per cent, still far from the RBI's comfort zone of 7 per cent.

If one looks at the global economic environment since the April policy announcement this year, conditions have only deteriorated. The danger of quantitative easing by the United States and the Eurozone to protect their economies is still hanging, which will result in a further rise in commodity prices.

There are also upside risks from the weak domestic currency due to a strong dollar and weak economic fundamentals. Dollar inflows through FIIs and FDI are still at abysmally low levels.

And, though the threat of Greece exiting Eurozone seems to have blown over, the possibility of the dollar appreciating still exists, which in turn would put pressure on rupee.

So inflation will come back through the currency route as it would increase the price of oil imports.

The current inflation rate - which touched double digits in 2011 - hovers around 7.5 per cent. The sudden shifting of focus towards growth by reducing rates would have given a fillip to domestic consumption.

Inflation then would have come back to hurt the market. But many question whether the end doesn't justify the means (used to contain inflationary pressure).

If rate hikes have failed to control inflation anyway, why sacrifice growth?