The hawkish stance adopted by the RBI did not come as a surprise. WPI inflation after remaining in double digits between March-July 2010, moderated to single digit during August-November 2010 followed by a sharp reversal in the trajectory in December, rebounding to 8.43% yoy. Key drivers of this discomforting headline inflation were food and fuel components, the first being a manifestation of supply rigidities and continuing structural imbalances and the second being an outcome of crude oil prices. Resolution of food inflation largely rests within domestic fiscal and administrative domain, containing fuel inflation has fewer domestic policy options (like reduction of customs/excise). As such policy making is at crossroads. The inherently slow nature of supply responses leave limited options in the near term but to lean heavily on monetary policy tools to prevent firm entrenchment of inflation expectations. Against this backdrop, significantly, the RBI stance changed its nuance from contain inflation and anchor inflationary expectation to containing the spill-over of high food and fuel inflation into generalized inflation
Unbridled optimism about economic growth a few months ago, has turned into cautious optimism in recent months with emergence of a few domestic macroeconomic uncertainties. Key among these being sustainability of fiscal discipline, vulnerability of current account deficit and the obvious - sticky and elevated inflation levels.
A realistic conclusion that emerges is that we may have to live with discomforting inflation prints and consequently see the monetary policy bear the burden of anchoring inflation expectations. We expect the RBI to deliver a few more policy rate hikes in our estimate by 75 bps by end of March 2012, albeit at a gradual pace. There is a degree of comfort in the central bank thinking that a calibrated approach enables the economy to absorb interest rate hikes better without seriously derailing the growth momentum. Inflation is an inequitable tax and with financial inclusion as a key support for a sustainable growth, the underlying focus of both monetary and fiscal policy will continue to be on inflation management.
* The author is chief economist, Yes Bank