RBI Dilemma

As I write this post, the Indian stock market continues bleeding over the steps taken by RBI yesterday to curb inflation, as they say. This RBI action and policy seems highly irrelevant to me, keeping in mind the nature of inflation at this point of time in India. The inflation is predominantly due to Supply side factors and is highly dependent on external factors. The RBI intent to reduce the demand is really not going to give substantial relief to the Government.

When I write this, I believe RBI Governors to be this cognizant of the situation and well averse in economics. Then why did this policy? The only reason I come out with is their hidden intent of reducing fiscal deficit through decrease in demand, primarily with imports. India is reeling through high amounts of fiscal deficit and it is going to shoot up seeing that there is no one time windfall gain like last year(It was 6.5% excluding the cash inflows of 3G auctions). The high debt levels of 78% makes Indian economy susceptible to economic shocks. Also, north bound oil prices are creating pressure on the Government to reduce the demand as a $10 rise in crude prices led to 0.3% increase in fiscal deficit of India.

Thus, this monetary policy of RBI is more governed by the Finance Ministry over reducing the nation's deficit. But the flip side is that it can lead to permanent/long term 'Crowding Out' of Private investments. The Growth rate estimates have declined to below 8% and could ruin the honeymoon period of the companies. But the valid question is whether double digit growth sustainable in an economy that is democratic, with limited/less natural resources (primarily energy) and an immature manufacturing sector? Moreover, Indian economy is highly dependent on the big developed countries for its revenues from service sector and it also does not peg its currency as China does to boost the exports. Keeping in mind these constraints, it is really a very difficult challenge for RBI to grow the economy by double digit while maintaining, if not reduce, the fiscal deficit at current levels.