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The Reserve Bank of India’s annual monetary policy announced on Tuesday was not as aggressive as most expected, but in his policy statement, the RBI governor, Duvvuri Subbarao, underlined a big worry: inflation. As part of the continuing calibrated rollback of the economic stimulus that was introduced to help the economy weather the effects of the global economic crisis prevailing through much of 2008 and 2009, the RBI raised its repo and reverse repo rates — the rates at which banks borrow from and lend to the central bank — by a quarter of a percentage point, or 25 basis points. The RBI also increased the cash reserve ratio — a reserve requirement — by 25 bps, reducing the amount of liquidity within the banking system. Both these measures — increasing policy rates and tightening liquidity — were aimed at addressing the pervasive and high inflation that consumers have been experiencing for months now, mostly in runaway food prices. Strictly speaking, monetary policy tends to use the wholesale price index or producer prices as an indicator in monetary policy making, but as the governor had pointed out in his January review, food price-led inflation (which is supply-side led) was becoming more generalized; rising incomes, capacity shortages and a liquidity overflow were driving up the demand side inflation too, which is the RBI’s area of responsibility. Technicalities aside, the RBI is the watchdog of inflation in public perception.

The policy statement outlined three concerns about the risks of high inflation: higher incomes could push up demand, higher oil prices could fuel inflationary pressures, and better economic performance could bring in higher capital flows (and thus more liquidity).The policy measures — in response to these concerns in the main — were met with both relief and worry, though in different quarters. As the governor pointed out, policy rates are still negative in real terms (or adjusted for inflation). So until real policy interest rates become neutral, there is wiggle room. A more aggressive policy stance — reflected in higher policy rate or CRR increases — would have almost certainly raised interest rates and forced many companies to rethink their investment plans, and perhaps dented the pace of economic recovery.

On the flip side, it could have sent out a strong signal regarding the central bank’s commitment to price stability. But the slightly softer approach is in line with the consistency of the policy thinking of the RBI governor: in other words, keeping the tightening calibrated, while also giving the central bank enough room to manoeuvre by raising rates quickly, should circumstances warrant it. So the tone of the policy statement is a little more concerned than that from other quarters of the government when it comes to inflation risks.

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