In the present episode, sterilised intervention was smooth and easy till January 2004. Since then, interest rate hikes began to be used in trying to reduce the liquidity being injected by the RBI’s dollar purchases. The first of the interest rate hikes was in October 2004. The reverse repo rate, the rate at which the RBI borrows from banks, was raised from 4.5 to 4.75 per cent. In October, the repo rate, the rate at which banks borrow from the RBI was raised from 6 to 6.25 per cent. Through a series of steps both rates were raised until March 2007, when the repo stood at 7.75 and the reverse repo at 6.0. At the same time, a large amount of liquidity was being sucked out through the sale of Market Stabilisation Scheme bonds which now stand at Rs 1.7 lakh crore. In December 2006, the CRR hikes began. The CRR was first hiked from 5 to 5.25 per cent. After that, a number of CRR hikes have taken it up to 8.25 where it now stands. This has resulted in a reduction in the growth of non-food credit to 22 per cent in March 2008, down from 31 per cent in December 2006.

However, in April 2008, the RBI’s net foreign exchange assets grew at a whopping 50 per cent over the last year. If the RBI continues to pump liquidity into the system like this, it will need many more CRR and interest-rate hikes before inflation comes under control. This could easily, as we have learnt from the events of the mid-’90s, lead to a sharp industrial slowdown. The policy of keeping the rupee weak may help some sections of industry, but surely the government must look at the broader economic consequences of the policy, and learn lessons from similar mistakes made in the past.

... contd.