If general elections are held as scheduled, whether or not most UPA politicians admit it or comprehend it, monetary policy will be a hidden poll issue. Home loan rates, as well as those on consumer loans, are set to rise again after RBI increased the cost of funds for banks. Lending rates in general may go up shortly. Industrial production is slowing down; the latest figures show a modest, by recent Indian standards, growth of 7 per cent. Of course, inflation is not moderating, and the impact of oil price hike hasn’t been felt yet. In the medium term, there will be no easing of inflationary pressure. Therefore, wise men tell us, higher rates, slowing growth, etc are the necessary price of fighting inflation. But wise men don’t tell us everything.

As our columnist explains, RBI’s policy choices are not transparent and we have no clear answers on some critical things. First, why were exchange rates thought to be more important to manage than inflation or growth? Second, given this exchange rate decision, why was the adjustment cost abruptly shifted more from the government to banks/households? RBI’s rate policy is frequently defended by saying it has to be hard on inflation. But the fact is that had RBI been really hard on inflation, it would have used all instruments available to fight it and started early. Instead, late last year, when inflationary pressure started building up, RBI was first pursuing the other goal of keeping the rupee down. An appreciating rupee — a dollar buys fewer rupees — is anti-inflationary because it makes imports cheaper and brings down the pressure on prices. Had the rupee been allowed to appreciate, there would have been much more flexibility on using interest rates and credit quantity as anti-inflationary measures.

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