Subbarao defends hawkish stance

RBI Governor D Subbarao strongly defended his monetary policy actions.

Reserve Bank of India Governor D Subbarao on Tuesday strongly defended his monetary policy actions especially the 12 hikes in repo rate since March 2010 to tackle soaring inflation saying,given the nature of the inflation drivers and their combined impact,clearly there is a significant role for monetary policy in combating inflation.

The inflation that we have experienced over the last nearly twenty months is a result of a combination of supply shocks that had a trend impact on prices as well as demand pressures. Our monetary policy stance is guided by this understanding,and is aimed at restraining demand and anchoring inflation expectations, he said while delivering a speech at the Stern School of Business,New York University on Monday. The argument of our critics that monetary policy has no role because inflation is a result of imported commodity prices would have been valid if the increase in commodity prices was a pure and transient supply shock or if there were no demand pressures. That clearly was not the case in India, he told the doves who criticised his policy actions as hawkish.

On monetary tightening hurting growth,Subbarao said,Another argument made in this line of criticism is that monetary policy tightening is hurting growth. I believe a much more nuanced evaluation of our policy stance is necessary. Evidence from empirical research suggests that the relationship between growth and inflation is non-linear. At low inflation and stable inflation expectations,there is a trade-off between growth and inflation. But above a certain threshold level of inflation,this relationship reverses,the trade-off disappears,and high inflation actually starts taking a toll on growth.

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Subbarao said estimates by the Reserve Bank using different methodologies put the threshold level of inflation in the range of 4-6 per cent.

With WPI inflation ruling above 9 per cent,we are way past the threshold. At this high level,inflation is unambiguously inimical to growth; it saps investor confidence and erodes medium term growth prospects. The Reserve Banks monetary tightening is accordingly geared towards safeguarding medium-term growth even if it means some sacrifice in near term growth, he said.

Defending the RBI actions,he said,the Reserve Bank has been battling inflation for the last 20 months. Monetary tightening,as is well known,works by restraining demand. In as much as the fiscal stance is supportive of demand,the monetary stance has had to be more aggressive than otherwise. For monetary policy to be more supportive of growth,it will be necessary for fiscal consolidation to take root more firmly.

On the criticism that the RBI is behind the curve in its actions,the RBI Governor said,If the above factors are reckoned with,the behind-the-curve argument loses potency. Starting in March 2010,we have so far raised policy interest rates (the repo rate) by 350 bp. The effective tightening has been even more,500 bp,as the operational policy rate shifted from reverse repo rate (absorption mode) to repo rate (infusion mode).

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On asset prices,he said the emerging view post-crisis is that central banks cannot remain indifferent to asset price bubbles.