I see a clear dichotomy in the stance of India’s central bank. While they seem to be vocally concerned about inflation, in reality they are more concerned about growth rather than the pressures of inflation.
It seems that food inflation running at double digit is looked at as an aberration and would moderate over the next few months. While this is partially true, it seems that they are either yet to gauge the full extent of inflationary pressure likely to hit India in 2011 (refer to my article http://www.atimes.com/atimes/South_Asia/LL23Df02.html) or they believe that since inflation is likely to be a global phenomenon this year, they have better arsenal to combat inflation viz. taking a sector specific stance rather than depending on the conventional monetary policy measures.
Today’s policy measures betrayed their over-riding fears of growth, which is showing signs of slowdown. Additionally, widening current account deficit (CAD), loose fiscal policy and high inflation can derail the growth prospects. However, despite knowing that high inflation can impede the growth prospects, RBI seem to be more concerned about likely slowdown in growth due to high interest rates, rather than a slowdown in growth due to inflation.
RBI has clearly been under estimating the inflationary scenario for a long time. They very fact that they have upped the inflation expectation by 150 bps (from 5.5% to 7%) at the fag end of the financial year, clearly exhibits that they were in a denial mode all this time.
That the RBI is yet unable to read the real signals properly is also clear from their expectation about India’s CAD. During Apr-Jun’10 the CAD was at 3.7% and they hope that India will end the financial year with a CAD of 3.5%. Even assuming that their expectation of slight moderation is correct, such levels of CAD will be debilitating for the economy. Yet, while RBI highlights that as a substantial threat, they do not seem to be doing much about it. Fact remains that high CAD implies that India is consuming more, much more than she should, given its level of exports and foreign exchange reserves. Yet RBI fails to catch the bull by the horn.
It is quite well understood that appropriate conduct of monetary policy requires tempering of the inflationary expectation. The RBI governor had the chance to make a bold statement but let it slip away and thereby India’s central bank continues to be behind the curve.