Inflation vs growth: RBI’s choice is clear

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Sunday , February 10, 2008 at 2332 hrs point cut on January 22 to 3.5% and the second on January 30 by 50 bps to 3% —the RBI governor told mediapersons after the policy announcement that its prime objective was that of curtailing inflation and keeping it below 5% levels. Its objective at the same time was to ensure stability through management of liquidity. Growth or a slowdown was not on the central banker’s immediate agenda.

This wasn’t the case with the Fed, as it was more into managing the tight money conditions there. Ditto for Bank of England that cut rates by 25 bps on Thursday.

Indian bankers initially were worried over the two Fed cuts and the widening interest rate differential that could lead to a few aggressive foreign banks raising cheaper money overseas and lending them here. The RBI is well in the know but has chosen not to act, at least for the moment.

The European Central Bank (ECB) too appears to have taken a cue from the RBI. On Thursday, ECB has done a similar act and left its benchmark rate untouched at 4% on Thursday.

Both the central bankers, the RBI and the ECB, have taken a similar stand—that of curbing inflation rather than supporting a weakening or slowing economy.

Fed and BoE, on the other hand, chose supporting a weaker economy through low rates.

The RBI, as one would realise by now, is focused on inflationary pressures caused by global oil prices and food prices. The government’s political stand of not passing on the oil price hike is making the task difficult for the RBI to curb inflation. The concern is more because consumer price index inflation is around 6% levels and the wholesale price index isn’t of much relevance. Taking these factors into consideration, inflation is more likely to pierce through the 5% target levels and could possibly rise another 150-200 bps.

Now, whether the central bank should support the economy or target inflation first is what bankers are hotly debating. The primary role of a central bank is to control inflation first and at the same time ensure there is adequate liquidity in the system to maintain growth. But that need not be always the case, given the Fed stand of lowering rates to boost growth that slowed down due to the subprime crisis.