Ripples on the brain

A few weeks ago, Ashok Desai of Business World, commented on the recent credit tightening efforts of RBI to fight inflation. Even in the previous weeks, he had argued that current inflation had little to do with demand and hence monetary tightening would do little to curb it (this even when RBI defended the tightening sighting that credit growth had neared 30% and bad credit had increased considerably).

In this particular column, he comes down hard on Dr.C.Rangarajan’s policies earlier as RBI’s Governor and now as the advisor to the Prime Minister. He’s especially severe on CR’s monetary tightening measures undertaken a decade ago which led to the destruction of many businesses and banking institutions and eventually, loss of growth for years together.

It was interesting to read some criticism of Dr.C.Rangarajan, after having been taught by him at the ISB. During the course, he had taught us in detail about the monetary policy instruments with the RBI and its advantages over the fiscal policy instruments.

With the sort of cycles that the economy goes through every few years, an observer gets an impression that growth invariably leads to inflation and over-heating and credit tightening by RBI which brings down growth. The only difference between now and a decade ago is probably that RBI is not tinkering with the exchange rate presently. But while RBI maintained the exchange rate when rupee was going down a decade ago, thereby hurting exporters, until a couple of weeks ago, rupee kept climbing and reaching new highs against the dollar. Any intervention by RBI in this instance would have anulled the effects of its tightening measures.

While RBI is probably justified in taking some measures to curb inflation, I’m not sure if there’s a scientific way to arrive a “cut off” for inflation. In India, “less than 5%” seems to good and “above 5.5%” seems to make people uncomfortable, though nobody clearly explains how these cut offs are arrived at. I read somewhere that the inflation numbers we track do not reflect the actual inflation experienced by an average household. In fact, inflation started reaching uncomfortable levels since last September or so, but it was not reflected in inflation numbers we track till a few months ago.