Credit Policy: RBI should infuse confidence
The past one year has been a tough one for the economy. Inflation has been confounding everyone from policy makers to economists.
July 23, 2011 / 17:09 IST
Arjun Parthasarathy
The last thing the economy needs is a central bank that is not showing confidence in itself. The past one year has been a tough one for the economy. Inflation has been confounding everyone from policy makers to economists. Inflation forecasts have gone horribly wrong with inflation consistently trending higher than forecasts. Inflation as measured by the WPI (Wholesale Price Index) at levels of 9.44% is higher by at least 200bps from even the most pessimistic of forecasters. The RBI had gone wrong in its forecasts of inflation and did not recognize the inflation threat until too late. RBI had to revise forecasts from 6% levels to 9% levels over the last six months. The sharp revision in inflation forecast prompted two rounds of rate tightening in May and June totaling 75bps. Inflation at present is expected to stay over 9% levels for the next few months before trending down. RBI has raised the repo rate cumulatively by 275bps over the last fifteen months to bring down inflation expectations. Yet, no one, from policy makers to economists to business leaders is standing up and saying that inflation is peaking. This is because of previous forecasts going completely wrong. In such a scenario where pessimism rules and no one is confident of the future trajectory of macro economic variables, the investment climate suffers. There tends to be a wait and watch policy where businesses put off investments and consumers put off consumption. This leads to a self-fulfilling spiral of a downward trajectory in economic growth variable.In such a scenario the RBI must be the leader. It must stand up and confidently say that the past anti inflationary policies is taking effect and that inflation is peaking out. It has admitted its earlier mistakes but that does not mean it will go on making mistakes. RBI has stood out in the past in taking bold steps especially during the years leading to the credit crisis of 2008 and it can take firm calls now. The best show of confidence in the policy review on the 26th of July 2011 will be a pause in policy rate hikes. If the RBI pauses and states that inflation is under control there cannot be a better confidence booster to the stakeholders in the Indian economy. Even if the RBI raises rates by 25bps and indicates inflation is under control, it will be a show of confidence. The worst show of confidence is a rate hike accompanied by uncertainty on inflation. It shows that the RBI does not have confidence in itself at present and that sends out wrong signals to the economy.We are all waiting for RBI to provide the confidence booster.
The author is editor www.investorsareidiots.com a financial web site for investors.
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