A fresh mandate for RBI

One striking feature of monetary policy in India has been the element of surprise. When inflationary pressures appeared in 2004, central banks all over the world responded by controlling inflationary expectations. The US Federal Reserve Bank raised the ‘federal funds rate’ in a calibrated manner, 17 times by 25 basis points each since July 2004, every time accompanied by statements that indicated where the Fed would go next. This policy framework kept inflation in the US under check. India, in contrast, lacked a coherent monetary policy. Changes in the repo rate, the reverse repo rate and the cash reserve ratio have repeatedly surprised the market, and have failed to keep inflation under check. Instead of calibrated changes in interest rates, consumers are now faced with sudden increases sharper than expected.

Data for RBI purchases only runs till January 2007. From April 2006 to January 2007, the RBI purchased USD 12.6 billion. In other words, the RBI quietly added Rs 56,543.05 crore to the domestic monetary base. It has not been able to fully “sterilise” these dollar purchases, so money supply has gone up. The RBI then turned around and tried to take steps to suck this liquidity out of the system. These steps included raising interest rates. Many borrowers now face higher loan rates and others, especially SMEs, have little access to bank credit.

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