In yet another indication that the Reserve Bank of India will press ahead with its calibrated rate hikes, the RBI Deputy Governor, Dr Subir Gokarn, on Tuesday said the central bank cannot afford to be slack on inflation merely because it is coming from a certain set of factors.
Monetary policy, according to the top RBI official, cannot stay idle on the assumption that inflation is not from the demand side.
In its mid-quarter monetary policy review last month, the RBI said that based on the current and evolving growth and inflation scenario it is likely to persist with the anti-inflationary stance.
Inflation vs growth
Allaying fears that hike in interest rates by the RBI could lead to a slowdown in investments, Dr Gokarn said it is better to have some constraint or restraint now with prospects of stabilisation later on, as against no restraint now and collapse later on.
“We don't want to be in a situation where the only way to deal with inflation is to squeeze out growth completely. Sustainability of growth in future requires lower inflation now,” the Deputy Governor said in his address to the members of industry body, FICCI.
The issue is not so much that of higher inflation posing a challenge to faster growth in the present. It is about the risks that higher inflation now poses for faster growth in the future. In other words, sustainability of growth over the long term does require controlling inflation, he explained.
Supply-side pressures
In his address, the Deputy Governor said that despite significant actions on both policy rates and liquidity by the Reserve Bank, inflation remains high. While supply-side pressures have clearly impacted headline inflation, the relatively brief and shallow slowdown did not fully eliminate demand-side pressures from the system and these too have contributed to the recent behaviour of inflation.
Dr Gokarn said that the country appears to be in a situation where supply-side pressures, arising from capacity constraints, are spilling over into generalised inflation. If, in fact, the contribution of investment spending to growth is declining, the constraints will further aggravate inflationary pressures if the growth momentum is kept going by other components of demand.
If there are signs of a spill-over from supply side to the core, then a monetary response is warranted to prevent the process from spiralling out of control, said the deputy governor.
“The challenge is to keep growth as high as possible without the risk of inflation spiralling out of control,” Dr Gokarn said.
Food prices
For much of the past several months, the dominant contributors to food inflation have been pulses, milk, eggs, fish and meat and fruits. The increase in prices indicates that supply is just not keeping pace with demand. The only way to keep food prices in check is to produce more of what people want to consume.
The configuration India needs to sustain growth is low inflation, high investment and fiscal consolidation, particularly on the revenue account. Both monetary and fiscal policies have a role in achieving this configuration.
The challenge for monetary policy is to prevent supply-side inflationary pressures from spilling over into more generalised inflation, both by managing expectations and by reigning in demand. This needs to be done with minimal disruption to growth, particularly investment activity. The challenge for fiscal policy is to bring down the fiscal deficit, particularly on the revenue account, Dr Gokarn said.
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