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Tackling inflation

The Reserve Bank of India (RBI) has decided to keep interest rates on hold at 7.50 per cent, choosing to wait and monitor inflationary pressures before making its next move. The next policy review is on June 2. During the press conference RBI Governor Raghuram Rajan voiced his impatience at banks dithering on lowering lending rates. A few hours after Rajan held his press conference, the State Bank of India, the country’s largest lender, slashed its base rate by 15 basis points. A basis point is one-hundredth of a percentage point. SBI slashed its rates post two leading banks-HDFC and ICICI slashing theirs in the last week. Whether consumer inflation stays within the target range of 2 to 6 per cent will play a key role in deciding future rate cuts by the RBI.

The consumer price index stayed within the target range of 5.37 per cent in February. This intense focus on inflation is a gradual unfolding of Rajan’s agenda of inflation targeting. The RBI Governor’s push comes close on the heels of the Centre agreeing for the first time to give the central bank a legal mandate to target inflation. “This makes explicit what was implicit before-that the government and the Reserve Bank have common objectives and that fiscal and monetary policy will work in a complementary way,” Rajan had said back then. These moves are the latest salvo in an onslaught of global easing.

The Reserve Bank of India’s in its monetary policy report points out a vexing problem staring at India’s policy makers. The report states, “Going forward, every unit of inflation lowered is going to mean larger output foregone”. This is probably an accurate assessment of the situation considering that the sacrifice ration has increased. The sacrifice ratio essentially means the total aggregate output losses than an economy must bear to reduce inflation. The report also makes no bones about targeting and pegging inflation at 4 per cent. The Indian economy may find that this task is a steep mountain to climb. To achieve both higher growth and lower inflation is a tough task to say the least.

For this utopian target to become reality India will have to sustain the current levels of disinflation by freeing up stalled investments, increase access to vital inputs such as land, power, infrastructure and human resources. If this does not happen then the supply side response will not show any tangible improvement and consequently any attempts at forcing down inflation would result in a lower rate of growth.

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