Post Lehman Crisis, the world scenario changed drastically forcing many nations to follow the accommodative measures so as to ease the liquidity deficit in the financial system. India, too, remained coupled to global events and remained unscathed from a global slowdown because of its increased integration with the global economy.
In India, the Central Bank, Reserve Bank of India took a series of accommodative measures to support the economy. Soon, the world scenario changed with confidence winning and improved numbers. However, the ease of liquidity put pressure on pricing which led to burgeoning of inflation. In real practice, India’s economy gets driven by two factors – first, domestic consumption story which, in recent years, improved on account of increased purchasing power due to various government sponsored initiatives and other factors and second, direct government aids to different sectors/industries in the form of duty cuts or other aids. The multiple factors also put pressure on inflation which also got imported, thanks to high commodity prices including crude oil, to a certain extent due to our large dependency on them.
In series of steps, the RBI hiked policy rates ten times successively, effectively by a total of 425 points since Mar 2010 in order to tame inflation which had been due to structural reasons too. Every time, RBI raises policy rates, it remains firm in taming the inflation which has become a toy of political storm too.
To support the fast transmission of policymaking, the central bank also made some changes in policy decisions – (1) introduction of base rate (2) the new Marginal Standing Facility (MSF) to support additional lending (3) restrictions on cross-lending between banks and mutual funds which have been rampant till some time ago. However, the RBI expressed its annoyance over the quality of data on which they have been operating the monetary policy. No doubt, the transmission of monetary policy has improved and to a large extent, the hiking of rates have slowed down the demand and also affected the economy growth, thanks to increased interest rates which have raised the average cost of capital. It has affected the capex investment too. In recent times, the RBI questioned the quality of data on Index of Industrial Production (IIP) which measures the industrial growth and Wholesale Price Index (WPI) which is also called as Headline Inflation; these data do not reflect the real economic activity. Volatility still persists in IIP and WPI. Even the recent improvements in IIP and WPI as per 2004-05 series have not helped the central bank; the data get revised by a wider spread on subsequent months. As evident, even the 10 rate hikes, one after another in the past 15 months have not dampened the demand effectively. In the last 2 years, economic forecasts from all government institutions, from Central Statistical Organisation (CSO) to RBI to Planning Commission have been questioned as they turned inaccurate. The high fiscal deficit and continuous gilt supply also kept RBI at bay in effective transmission of monetary policy.
Also, read – Price Hikes – Are we really ready?
Does it say RBI has failed?
Not really! In the past, RBI had been instrumental in taking the country out of the century worst financial crisis; so, it won’t be good to comment on their effectiveness. Their hands are also tied in terms of data availability, political interference (though it is said that RBI is not under the government interference but not in real sense) and dynamic nature of the situation. The various structural issues including supply-related factors also waned the effectiveness of policy transmission. The persistently high food inflation in the last two years has migrated to manufacturing inflation too.
The RBI says that they are handicapped by the reliability of some of the basic data that they need to use in policy calculations which remains true to a large extent. In a nut-shell, India’s inflation must drop before it eats the economy; hope the government must be listening to improve the effectiveness of policy making which are indirectly linked to them.
Happy Reading!
- Amar Ranu
