The RBI?s action is broadly in line with my expectation. Inflation has scaled a 13 year high of 11.91% and is expected to stay at double digits for some more months. The recent depreciation of the currency further aggravated the impact of supply side shock from global commodity, oil and to some extent food prices. Over the last 2-3 years, monetary tightening by RBI notwithstanding, money supply growth has remained above the RBI?s target. Even in this fiscal, money supply growth at 20.5% has remained above the RBI?s target. The RBI has also expressed discomfort over high credit growth. Its prognosis of the economy released a day before the Policy announcement clearly pointed towards further tightening.
The pressure on domestic inflation from a supply shock cannot be addressed directly by monetary tightening. But the supply side shock can translate into second round cascading effects if the shock is strong and persistent and is supported by easy monetary conditions. The RBI had expressed concern that the spike in oil and commodity prices was not a temporary phenomenon. Monetary tightening was therefore needed given the quantum of the supply side shock and its expected persistence going forward. It is not that the past tightening by RBI did not have the desirable effect of trimming demand. The effects of past monetary tightening are still coming through and an unfavourable external scenario is likely to moderate growth further.
The latest IIP data reveals that interest sensitive segments such as consumer durables are slowing down and there is some evidence of postponement of investment decisions. Despite this, the RBI has raised repo and CRR to mute the second round effects of the supply side shock to prices and anchor inflationary expectations.
Without this, the economy would have been exposed to mounting risk on the inflation front.
?The author is director and principal economist, Crisil