Choosing the Right Instrument

There has perhaps never been a more challenging backdrop against which the Reserve Bank of India (RBI) has had to formulate its annual credit policy as for 2008-09. There was the resurgence of domestic inflation that had broken through the RBI’s indicative target of 5 per cent, global inflation in commodity prices that was having a strong impact on domestic price pressures, the continuing international financial turmoil that was beginning to show signs of reaching Indian shores and, of course, evidence of a moderate slowdown in economic growth. To add to these many challenges the RBI had to cope with a cacophony of voices and lobbies that pressed hard for the central bank not to sacrifice growth for price moderation – i e, that were lobbying against a hike in interest rates. In addition, a new kind of advice came in the form of half-baked theories to let the rupee appreciate and use this appreciation to fight inflation.

In the event, the RBI has retained its capacity to surprise and has stuck to using the blunt instrument of the cash reserve ratio (CRR), raising it by 25 basis points within a fortnight of the last hike. Over the course of less than a year the CRR has been increased by 175 basis points and effective May 24 it will stand at