RBI sacrifices growth to rein in inflation

The Reserve Bank of India on Tuesday finally abandoned its baby-step approach to tame inflation and stepped up its offensive even at the cost of growth. The change in strategy came after RBI governor Duvvuri Subbarao acknowledged that inflation estimates had “overshot even the most pessimistic projections”. The RBI’s move has been guided by the fact that inflation, which stood at nearly 9% in March, is expected to remain at elevated levels and may even get worse during the year. The finance ministry, which has been resisting any big bang approach to calm price pressures so far, seems to have come around to accepting the RBI’s prescription. Judging by the comments from North Block, it seems the ministry is also ready to sacrifice some growth in the short term to preserve long-term growth. Any talk of double-digit growth has been put on the back burner for now. The RBI expects growth in FY12 to be around 8% with a 90% probability of it being between 7.4% to 8.5%—below the government’s estimate of nearly 9%. So far policymakers have been basking in the glow of accelerating growth. Consequences of slower growth is expected to emerge as a political challenge now. It will have consequences for consumers, interest rate sensitive sectors such as real estate and others. But for the RBI, which has been criticized for being behind the curve, controlling inflation seems to be the singlemost policy challenge for now. Policymakers have been wrong-footed on inflation several times and their projections have been way off the mark. Some economists, however, say they do not expect any near-term impact of the aggressive tightening on inflation. The RBI says that while the monsoon is expected to be normal, its impact on moderation in food inflation may be less than commensurate. RBI’s baseline projection for estimate in March 2012 is 6% with an upward pressure. Most economists expect another 50 to 75 basis point increase in rates. The ball is now in the government’s court. There will be pressure to improve supplies and stick to its fiscal targets against the backdrop of rising global crude and commodity prices. Fuel prices, which have been capped due to the elections, will now need to be hiked to fight inflation.