Opinion The two RBIs

Its interventions in forex markets are at odds with its stance on inflation.

April 2, 2014 01:12 AM IST First published on: Apr 2, 2014 at 01:12 AM IST

Its interventions in forex markets are at odds with its stance on inflation.

Inspite of persistent calls from certain sections of industry to cut the repo rate, the RBI maintained status quo in its first bi-monthly monetary policy review. In doing this, the RBI exhibited a heartening determination to fight consumer price index inflation. But the central bank’s recent interventions in the foreign exchange market to prevent the rupee from appreciating “too much” on the back of a deluge of foreign institutional investor inflows — at Rs 20,077 crore, FII inflows reached a 10-month high in March — are misguided and may undercut its efforts to contain inflation.

By keeping the repo rate at 8 per cent, rather than raising it, the RBI acknowledged the moderation in CPI inflation, which has declined from 11.2 per cent in November 2013 to 8.1 per cent in February, a 25-month low. This is still above the RBI’s target, which was mooted by the Urjit Patel committee, of achieving 8 per cent CPI inflation by January 2015. Equally, by not lowering the policy rate, the RBI nodded to the significant upside risks to inflation.

The moderation that has been witnessed is mostly on account of easing vegetable prices — while CPI inflation has declined 3.1 percentage points since last November, core CPI inflation has only declined 0.1 percentage points. But the possibility of another food-price shock remains high. Barring 2011-12, food inflation has been above 8 per cent every year since 2007-08, even though this has been a period of mostly normal monsoons. This year, there is the added threat of El Nino, which could prove disruptive for the rains. Further, CPI inflation has not been stable at a low level long enough for the high and deeply entrenched inflation expectations to change.

But there is a contradiction between the RBI’s stance on inflation and its exchange rate targeting — it has been aggressively buying dollars in forex markets to dampen the rupee’s appreciation. If this intervention is unsterilised, the pumping of liquidity into the market by buying dollars will lower interest rates and counteract the RBI’s efforts to target inflation, as happened in the mid-2000s.

The RBI must allow the exchange rate to float freely. If it is worried about the fallout of the US Fed’s unconventional monetary policy, the only solution is for India to maintain low inflation and low current account and fiscal deficits.

# RBI