Inflection point: RBI first policy increase in four years must be complemented by fiscal prudence

Reserve Bank of India’s monetary policy committee on Wednesday increased the policy interest rate by a quarter percentage point to 6.25%, the first time in over four years. It signals the MPC’s concern about inflation risks, particularly on account of higher input cost pressures. The decision is also in sync with what many emerging markets have done to deal with an outflow of foreign portfolio investment on the heels of monetary and fiscal policy changes in the US.

Given underlying trends in inflation and financial markets, an interest rate increase this year was inevitable. RBI’s task is only going to get tougher in the months ahead. This is primarily on account of the need to support prospects for economic growth. Over the last year, not only have the disruptive influences of decisions such as demonetisation receded, investment has also begun to pick up. At this juncture, RBI must walk a tightrope to fulfil its mandated job of keeping inflation under check and ensuring that an economic recovery is not choked. Going ahead borrowers at both individual and corporate levels will have to pay a higher price. Savers, however, will benefit as nominal interest rates on deposits will head up.

India’s policy makers have no control over price of crude oil and global financial volatility, two important sources of risk to economic recovery. There is one area of risk which can be controlled by governments. Both growth and stability will be adversely affected at this moment if governments opt to get fiscally reckless in an election year. Not only will it make the economy more vulnerable through the financial market channel, it will also crowd out private firms trying to raise capital for investment. Therefore, the most important message of monetary policy is that governments must refrain from fiscal populism. That approach will support growth and create jobs.

This piece appeared as an editorial opinion in the print edition of The Times of India.
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via Inflection point: RBI first policy increase in four years must be complemented by fiscal prudence

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