Its time fiscal policy took over the burden of anchoring inflation

Written by Shubhada Rao | Shubhada Rao | Updated: Sep 17 2011, 08:06am hrs
Reserve Bank of Indias mid-quarter review was eagerly anticipated; as expected, the recent turmoil in the global economy found ample consideration in RBIs rhetoric, citing the global situation as a matter of serious concern. While the commentary acknowledges this, domestic developments yet precede in focus warranting the monetary policy stance to remain hawkish with headline inflation ruling close to double digits. Stepping off its anti-inflation stance prematurely would perhaps have been destabilising for anchoring inflationary expectations, which the RBI has effectively managed to rein in through its past policy actions.

The domestic economy has begun to exhibit signs of a moderation in growth. PMI manufacturing declined for the fourth consecutive month in August to a two-and-a-half year low. Until now, buoyant services PMI component also slumped sharply in the month.

With downside risks to growth in advanced economies magnifying, Indian exports are unlikely to sustain their exceptional strength. On inflation front, the sequential momentum in core inflation has corrected by almost 100 bps from Q4 FY11 to Q1 FY12 on a both seasonally adjusted and unadjusted basis. This is clearly an early sign of inflationary pressures easing in the economy.

Amid a combination of a moderating growth and easing inflation, the RBI has stated that the cumulative impact of policy actions should now be increasingly felt in further moderation in demand and a reversal of inflationary trajectory towards the later part of 2011-12. We believe this builds a case for the end of monetary tightening. The key risk to our view emanates from a sharp rally in commodity prices in the event of another round of quantitative easing by the Fed. Although this is a possibility, the impact on commodity prices could be offset by the loss in recovery momentum in developed economies.

With monetary policy at its inflexion, there is a growing need for fiscal policy having to play an incrementally greater role in curbing demand side pressures, which the RBI acknowledged in its Annual Monetary policy statement. A hike of R3 in petrol prices, while having a limited upside impact on headline inflation, is a token measure in curtailing fiscal slippage. Hitherto, the monetary policy has solely borne the burden of anchoring inflation expectations. Its time for fiscal policy to take over!

The writer is chief economist, Yes Bank