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.

But we are past that point now. Small firms and middle-income households are getting squeezed on business credit and home loans. In political-economic terms, this means that the incumbent government, despite having presided over three years of great growth performance, will be associated with avoidable cost increases for households and small business. UPA strategists have been arguing that inflation loses more votes than growth wins. Since the Congress got urban votes in the last elections and since an increasingly urbanising India is carrying the burden of a strange monetarist orthodoxy, the Congress may find out how off-the--mark its theory is and how much it hurts electorally.