RBI monetary policy effectiveness containing inflation

RBI'S MONETARY POLICY INITIATIVES SINCE 2008-09 AND ITS EFFECTIVENESS IN CONTAINING INFLATION
PROJECT OF MACROECONOMICS
ON
RBIS MONETARY POLICY INITIATIVES
SINCE 2008-09 AND ITS EFFECTIVENESS IN CONTAINING INFLATION
SUBMITTED BY ARPIT PANGASA (11DM032) GUNJAN GODWANI (11DM052) RIDHI PRASAD (11DM122) UNDER THE GUIDANCE OF PROF. JAGDISH SHETTIGAR
BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA
RESERVE BANK OF INDIA

It is the central banking institution of India and controls the monetary policy of the rupee. The institution was established on 1 April 1935 during the British Raj in accordance with the provisions of the Reserve Bank of India Act, 1934. Reserve Bank of India plays an important part in the development strategy of the government. It is a member bank of the Asian Clearing Union. Reserve Bank of India was nationalised in the year 1949. The general superintendence and direction of the Bank is entrusted to Central Board of Directors of 20 members, the Governor and four Deputy Governors, one Government official from the Ministry of Finance, ten nominated Directors by the Government to give representation to important elements in the economic life of the country, and four nominated Directors by the Central Government to represent the four local Boards with the headquarters at Mumbai, Kolkata, Chennai and New Delhi. Local Boards consist of five members each Central Government appointed for a term of four years to represent territorial and economic interests and the interests of co-operative and indigenous banks.
INFLATION
Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects erosion in the purchasing power of money a loss of real value in the internal medium of exchange and unit of account in the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time. It is not just the monetary policies formulated by the RBI but also the Fiscal policies formulated by the government that can affect inflation.
RECESSION
It is a period of general economic decline; typically defined as a decline in GDP for two or more consecutive quarters. A recession is typically accompanied by a drop in the stock market, an increase in unemployment, and a decline in the housing market. A recession is generally considered less severe than a depression, and if a recession continues long enough it is often then classified as a depression. Many factors contribute to an economy's fall into a recession, but the major cause is inflation. The higher the rate of inflation, the smaller is the percentage of goods and services that can
be purchased with the same amount of money. Inflation can happen for reasons as varied as increased production costs, higher energy costs and national debt. In an inflationary environment, people tend to cut out leisure spending, reduce overall spending and begin to save more. But as individuals and businesses curtail expenditures in an effort to trim costs, this causes GDP to decline. Unemployment rates rise because companies lay off workers to cut costs. It is these combined factors that cause the economy to fallintorecession.
MONETARY POLICY
The Monetary and Credit Policy is the policy statement, traditionally announced twice a year, through which the Reserve Bank of India seeks to ensure price stability for the economy. These factors include - money supply, interest rates and the inflation. In banking and economic terms money supply is referred to as M3 - which indicates the level (stock) of legal currency in the economy. Besides, the RBI also announces norms for the banking and financial sector and the institutions which are governed by it. These would be banks, financial institutions, nonbanking financial institutions, Nidhis and primary dealers (money markets) and dealers in the foreign exchange (forex) market. RBI uses the following tools: a) Bank Rate: Bank Rate is the rate at which central bank of the country ( Bank Rate in
India is decided by RBI) allows finance to commercial banks. Bank Rate is a tool, which central bank uses for short-term purposes. Any upward revision in Bank Rate by central bank is an indication that banks should also increase deposit rates as well as Base Rate / Benchmark Prime Lending Rate. Thus any revision in the Bank rate indicates that it is likely that interest rates on your deposits are likely to either go up or go down, and it can also indicate an increase or decrease in your EMI. b.) Cash Reserve Ratio: The Reserve Bank of India (Amendment) Bill, 2006 has been
enacted and has come into force with its gazette notification. Consequent upon amendment to sub-Section 42(1), the Reserve Bank, having regard to the needs of securing the monetary stability in the country, RBI can prescribe Cash Reserve Ratio (CRR) for scheduled banks
without any floor rate or ceiling rate [before the enactment of this amendment, in terms of Section 42(1) of the RBI Act, the Reserve Bank could prescribe CRR for scheduled banks between 3 per cent and 20 per cent of total of their demand and time liabilities]. RBI uses CRR either to drain excess liquidity or to release funds needed for the growth of the economy from time to time. Increase in CRR means that banks have less funds available and money is sucked out of circulation. Thus we can say that this serves duel purposes i.e.(a) ensures that a portion of bank deposits is kept with RBI and is totally risk-free, (b) enables RBI to control liquidity in the system, and thereby, inflation by tying the hands of the banks in lending money. c.) Repo Rate: The discount rate at which a central bank repurchases government
securities from the commercial banks, depending on the level of money supply it decides to maintain in the country's monetary system. To temporarily expand the money supply, the central bank decreases repo rates (so that banks can swap their holdings of government securities for cash). To contract the money supply it increases the repo rates. Alternatively, the central bank decides on a desired level of money supply and lets the market determine the appropriate repo rate. Repo is short for repossession. d.) Reverse Repo Rate: Reverse Repo rate is the rate at which Reserve Bank of India
(RBI) borrows money from banks. Banks are always happy to lend money to RBI since their money are in safe hands with a good interest. An increase in Reverse repo rate can cause the banks to transfer more funds to RBI due to this attractive interest rates. It can cause the money to be drawn out of the banking system.
Due to this fine tuning of RBI using its tools of CRR, Bank Rate, Repo Rate and Reverse Repo rate our banks adjust their lending or investment rates for common man. e.) Prime Lending Rate: The interest rate charged by banks to their largest, most secure,
and most creditworthy customers on short-term loans. This rate is used as a guide for computing interest rates for other borrowers. It is also called prime rate.
FISCAL POLICY
It is the means by which a government adjusts its levels of spending in order to monitor and influence a nation's economy. It is the sister strategy to monetary policy with which a central bank influences a nation's money supply. These two policies are used in various combinations in an effort to direct a country's economic goals.
WHOLESALE PRICE INDEX

It is an index that measures and tracks the changes in price of goods in the stages before the retail level. Wholesale price indexes (WPIs) report monthly to show the average price changes of goods sold in bulk, and they are a group of the indicators that follow growth in the economy. The Wholesale Price Index (WPI) is used extensively as a measure of inflation and important monetary and fiscal policy changes are often linked to it. The WPI indices are also used for the purpose of escalation clauses in the supply of raw materials, machinery and construction work. The weekly index numbers of wholesale prices have acquired considerable significance over time, since this is the only index which gives an idea of the week-to-week fluctuations in the prices of all the traded commodities. The WPI in its role as a guide to policy formulation has several critical limitations. The important limitations relate to (a) non-inclusion of services (b) following a fixed weighting scheme while the economy is undergoing major structural changes, and (c) use of gross transactions data rather than data on final purchases.
Inflation Measures in India WPI in India is used extensively for short term policy intervention because it is the only index that is available on a weekly basis with a two weeks lag. In principle, inflation requires to be managed with respect to changes in prices of final goods or consumer prices. A number of consumer price indices like Consumer Price index for Industrial Workers (CPIIW), for Agricultural Labourers (CPI-AL), and for Urban Non-Manual Employees (CPIUNME) are compiled on a monthly basis. This index is also used for determining the dearness allowances to be paid to Central and State Government employees and to industrial workers besides fixation and revision of minimum wages to scheduled employments. As on today, India uses a basket of 435 commodities and a base year of 1993-94 for its Wholesale Price Index (WPI) based inflation rate calculation. The 435 commodities used for finding WPI range from food items like rice, wheat to petroleum products to medicines and are given weightings depending upon their importance and impact on the economy. Discussions are going on to revise the number of commodities to 980 and base year to 2004-05. The 435 commodities are divided to various groups and subgroups. Individual commodities, and as a result, groups and subgroups have weightings. On a broader level, the 435 commodities are grouped into:
Primary Articles Fuel, Power, Light and Lubricants Manufactured Products
Primary Articles consist of food grains, fruits and vegetables, milk, eggs, meats and fishes, condiments and spices, fibers, oil seeds and minerals. Fuel, Power, Light & Lubricants consist of coal and petroleum related products, lubricants, electricity etc. Manufactured Products consist of dairy products, atta, biscuits, edible oils, liquors, cloth, toothpaste, batteries, automobiles etc. The group weightages
are 22.02525%, 14.22624% and 63.74851% for Primary Articles, Fuel, Power, Light & Lubricants and Manufactured Products respectively. The total adds up to 100. There are three more parts to this article. In the first part, we will cover Primary Articles, its sub classifications, individual commodities and their weightages. Second part is for Fuel, Power, Light & Lubricants, its sub classifications, individual commodities and their weightages and third part deals with Manufactured Products, its sub classifications, individual commodities and their weightages.
INFLATION TREND IN INDIA
Labels in Green: Contractionary Policy Labels in Dark pale pink: Expansionary Policy
INFLATION IN THE PRIMARY SECTOR: AGRICULTURE

YEAR 2008-09 During the last two decades several challenges have surfaced in Indian agriculture which are becoming more and more severe in recent times. These mainly relate to slow growth of productivity, efficiency, equity and sustainability. The biggest challenge was the low growth rates in agriculture of -0.1%, 0.4% and 5.4% in 2008-09, 2009-10 and 2010-11. Another challenge is to ensure sustainable use of natural resources. The third big challenge is improved marketing, transport and warehousing. The 2011-12 Budget of India also focussed on increasing warehouses for proper supply of agricultural produce and efficient supply chain management so supply-side bottlenecks, which also lead to high prices and thus high inflation could be removed. Focussing on the policy-making, we can see from the above table that 2008 started with a low inflation at the rate of 3.79%. However the inflation set a rising trend since then, with inflation going to 12% in September, 2008. The inflation trends for the year 2008-09 show that while the group inflation rate as on end-March 2009 registered at 5.2 per cent, it was 7.0 per cent in food articles, 0.1 per cent in non-food articles and 7.2 per cent in minerals.
This was driven largely by the rapid rise and equally rapid fall in global commodity prices during January 2008 to March 2009. Global food prices also went through a similar cycle, but did not decline to the same extent. Though domestic food prices are partially delinked from global prices, these global developments affected domestic prices to some extent. Domestic food price inflation, as measured by the WPI food sub-index, though declining, remained much higher than overall inflation. Nearly two-thirds of this rise in inflation was due to three sets of commodities namely, edible oils (including oilseeds and oilcakes), iron and steel (including iron ore) and mineral oils and refinery products. The deceleration of growth in 2008-09 was spread across all sectors except mining & quarrying and community, social and personal services. The growth in agriculture and allied activities decelerated from 4.9 per cent in 2007-08 to 1.6 per cent in 2008-09, mainly on account of the high base effect of 2007-08 and due to a fall in the production of non-food crops including oilseeds, cotton, sugarcane and jute. The production of wheat was also marginally lower than in 2007-08. On the domestic front, apart from the global demand-supply aspects, the minimum support price (MSP) system also has a critical role on the ruling prices. From 2007-08, the jump in the MSP of various crops could have contributed to the increase in inflation rates for agricultural commodities. While during 2000-01 to 2006-07, the rise in the basic MSP (excluding bonus) had been gradual, in 2008-09, the MSP in almost every crop had witnessed increases of about 30 per cent or more. This was particularly pronounced in pulses, cereals and edible oils.
YEAR 2009-10 The fiscal year 2009-10 has been a time of inflationary concerns. It was a year of a somewhat unusual inflation. While food inflation soared, inflation in the non-food sector was negligible. The Government was concerned that the upward pressure on prices should not escalate to all sectors. And, at least till January, the experience was that of highly skewed food-sector inflation. The weekly food price inflation on a year-on-year calculation reached a maximum of 19.95 per cent for the week ending December 5, 2009. Since then the pressure has eased off a little. In 2009-10 (April- November), food inflation was 12.6 per cent and non-food inflation minus 0.4 per cent. If we look at Indias inflation history from 1971, this kind of inflation, where food inflation is above 10 per cent and non-food inflation is negative, has happened only twice before.
What was occurring from the middle of 2008 to early December 2010 is best described as skewflation. India faced a dilemma in December 2009 when our core inflation remained negligible while food inflation was large. One silver lining of such skewflations is that, unless one injects excessive demand into the economy through lax monetary policy, they do not last long. The primary cause of the 2009-10 food-price inflation was the severe drought of 2009, which caused a downturn in food production in the third quarter of 2009-10 and the expectation of the resultant price rise itself fed further into the inflation. Government reacted carefully by easing up imports of relevant food-grains and sugar and also releasing wheat and rice from the stocks held by the Food Corporation onto the market.
YEAR 2010-11 The important thing to note here is that during the years 2007-10, the Indian economy has been severely buffeted by but has successfully withstood two shocks in rapid succession : (a) a collapse in world growth, finances and trade with the onset of the global financial crisis of 2007-09 whose ripple effects continued in 2009-10 and persisted in 2010-11 (with fiscal stresses in Europe). (b) Domestically, following a year of negative growth in agriculture and allied sectors in 2008-09, erratic monsoons resulted in a severe drought in 2009-10 and unseasonal late rains affecting the winter crops in 2010-11. In this year too, inflation in primary articles particularly food articles was the main contributor to the elevated levels of WPI inflation. With diminishing base effect, there was a gradual moderation in overall WPI inflation in November 2010 when it was placed at 7.48 per cent. There was again a rise in December 2010 driven mainly by certain food articles (fruits and vegetables, egg, meat and fish) and also petroleum products. On the basis of weekly data on prices, inflation in food articles remained in double digits for 76 weeks from 5 June 2009, after briefly ruling below the double digit mark for three weeks between 20 November 2010 and 4 December 2010. While food inflation has remained high even in 2009-10, compositionally the higher inflation this year is different ; last year the main drivers were pulses, cereals and sugar which could be attributed to monsoon deficiency whereas during 2010-11, inflation seemed to be driven by demand factors despite higher supply levels.
Some clouds still linger such as continued high food inflation and temporary industrial slowdown, despite governments efforts to contain it.
INFLATION IN THE SECONDARY SECTOR: INDUSTRY FINANCING AND INVESTMENT

On a year-on-year basis, credit growth to industry sharply accelerated to 27.0 per cent in November 2010 from 14.2 per cent in November 2009. The sectoral composition of the gross deployment of bank credit to industry, including infrastructure, shows widely varying patterns. It is the infrastructure sector that kept credit growth to industry at the level of 27.0 per cent during the year ended November 2010. Regarding industrial investment, the industry sector has been attracting a sizeable chunk of domestic capital formation resulting in an addition to productive capacities. There was a decline in the share of industry GCF in the total GCF in 2008-9, which could be considered an abnormal year because the global economic meltdown had affected investor sentiment resulting in a dip in investment and deferment of investment decisions. The internal accruals of the corporate sector were also adversely affected. A decline in stock market indices also affected valuation gains and the combined effect of these factors led to a decline in industry GCF. But during 2009-10, industry GCF as a share of overall GCF has increased to 43.8 per cent due to revival of investment sentiments. While the FDI inflows have somewhat flattened out over the course of the last three years, the pace of inflows has been stable, including during 2009-10. Also in 2010-11(April November), there was a total of 7831.2 US $ of FDI inflow. This is despite the fact that the United Nations Conference on Trade and Development (UNCTAD) World Investment Report (WIR), 2009, had noted a fall in global FDI inflows. In FDI equity investments, Mauritius tops the list of first ten investing countries followed by the US, the UK, Singapore, Netherlands, Japan, Germany, France, Cyprus, and Switzerland. Among the sectors attracting highest FDI are services, telecommunicate ions, computer software and hardware, housing and real estate, and construction. Sectors like agricultural services, sea transport, and electrical equipment have shown a quantum jump in FDI inflows during 2009-10.
INDEX OF INDUSTRIAL PRODUCTION (IIP)

From the above table, we can see that during the first two quarters of 2008-09, the IIP was 5.6% and 5.2% respectively. The third quarter of 2008-09 witnessed a sharp decrease in IIP owing to the recession experienced worldwide. Hence, to counter the recession, RBI had to shift its stance from contractionary policy to expansionary policy. The graph given below exhibits the movement of IIP rates.
But even the changes in policies were not effective and IIP further fell down to 1% from 1.5% in the fourth quarter of 2008-09. The main sectors affected during these two quarters were manufacturing and intermediate goods. The RBI kept its monetary policy stance towards expansionary policy from October, 2008 to January, 2010, the effects of which can be clearly seen in the increase in IIP from 1% in the last quarter of 2008-09 to 4% in the first quarter of 2009-10 to 8.6% in the second quarter to 13.3% in the third quarter and 15.8% in the last quarter. The major sectors contributing to this phenomenal growth were capital goods and manufacturing. The RBI has been following the contractionary policy since February, 2010. Even now, the RBI has been following the same policy. The effect of these policies can be clearly seen in the decrease in IIP since the first quarter of 2010-11. The IIP fell down from 15.8% in the last quarter of 2009-10 to 11.9% in the first quarter of 2010-11, to 9.1% in the second quarter, to 5.3% in the third quarter and fourth quarter of 2010-11. The major sectors that contributed to the decrease in the IIP were manufacturing, capital goods and intermediate goods. However, the first quarter of 2011-12 saw an increase in the IIP from 5.3% to 6.7%. Although this trend
could not continue for long and the second quarter of 2011-12 saw a decrease in the IIP again from 6.7% to 6%.
INFLATION IN THE TERTIARY SECTOR: THE SERVICE SECTOR

India stands out for the size and dynamism of its services sector. The contribution of the services sector to the Indian economy has been manifold: a 55.2 per cent share in gross domestic product (GDP), growing by 10 per cent annually, contributing to about a quarter of total employment, accounting for a high share in foreign direct investment (FDI) inflows and over one-third of total exports, and recording very fast (27.4 per cent) export growth through the first half of 2010-11. The investment in the services sector can be seen through the following graphs:Number of Greenfield FDI Projects in Services Industries 20072009
SECTOR
HOTELS & TOURISM TRANSPORT, STORAGE AND COMMUNICATIONS COMMUNICATIONS FINANCIAL SERVICES BUSINESS SERVICES
2007
297 1024 448 1161 2922
2008
553 1269 594 1616 3647
2009
370 1133 544 1267 2927
Due to the financial crisis in 2009 the investments (FDI) went down in the service sector. On the positive side, at global level, medium term prospects for services are generally better than those for the manufacturing sector with international investment in the services sector expected to grow relatively faster. In addition, many service transnational companies, which some years ago were mainly focused on their home markets, are now pursuing internationalization strategies involving ambitious investments abroad. Developing and transition economies, particularly in Asia, are considered as most attractive destinations. India has been ranked among the top 12 service exporters of the world in 2009.
MONETARY DEVELOPMENTS EMERGING TRENDS IN 2008-09

Due to an extraordinary economic situation all around the world, makers of monetary policies have had to show great innovation to counter it. While the task of monetary management by the RBI in India has centred on managing a judicious balance between price stability and sustaining the growth momentum, the global financial turmoil reinforced the importance of preserving financial stability through prudent regulatory surveillance and effective supervision. The current policy challenge, accordingly, was perceived as the need to strike an optimal balance between preserving financial stability, maintaining price stability, anchoring inflationary expectations, and at the same time sustaining the growth momentum. During financial year 2007-08 in the backdrop of increased capital inflows, changes in the policy rates mainly involved the cash reserve ratio (CRR) (which was increased by 150 basis points from 6.0 per cent as it prevailed on April 1, 2007 to 7.5 per cent w.e.f. November 10, 2007); the repo rate (RR) at 7.75 per cent and the reverse-repo rate (R-RR) at 6.0 per cent were left unchanged. During the first six months of the financial year 2008-09, RBI consciously endeavoured to control monetary expansion through increases in CRR and RR. These have been explained in the table mentioned above. In addition, sector specific steps to ease liquidity were introduced (which shall be covered when we deal with the different sectors individually), in consonance with an upward revision of the indicative target growth rates for broad money and bank credit to the commercial sector.
Update on monetary policy stance during 2009-10:

The monetary policy in 2008-09 had to address the emerging economic situation, wherein the position in the second half of the year was substantially different from the first half. The policy had to contend with the spill-over effects of the global financial crisis, on the countrys growth path. The liquidity situation had improved significantly towards the end of 2008-09, in the wake of measures taken by the RBI. For the year 2009-10, RBI has envisaged a macroeconomic scenario with the real GDP growth at 6.0 per cent and WPI inflation to be around 4.0 per cent by end-March 2010. Consistent with this, the growth in aggregate deposits of scheduled commercial banks has been projected to grow at 18.0 per cent and non-food credit by 20.0 per cent. The Annual Policy Statement for 2009-10 was announced on April 21, 2009. Therein marginal reductions in the policy rates have been announced.
The monetary policy stance for 2009-10 aims to:
Ensure a policy regime that will enable credit expansion at viable rates while preserving credit quality so as to support the return of the economy to a high growth path.
Continuously monitor the global and domestic conditions and respond swiftly and effectively through policy adjustments as warranted so as to minimize the impact of adverse developments and reinforce the impact of positive developments.
Maintain a monetary and interest rate regime supportive of price stability and financial stability taking into account the emerging lessons of the global financial crisis.
ACTUAL MONETARY POLICY STANCE DURING 2009-10

Conditioned by the need for monetary policy to respond to the then slackening economic growth, the RBIs monetary policy stance during 2009-10 was aimed at providing a policy regime that would enable credit expansion at viable rates while preserving credit quality so as to support the return of the economy to a steady growth path. The Annual Policy Statement of the RBI for 2009-10 (April 21, 2009) clearly indicated the continuance of the policy being followed since mid-September 2008 to minimize the impact of the global financial crisis on the domestic economy and restore the economy to a high growth path consistent with price and financial stability. For achieving this, the different policy measures and the changes brought about at different times of the year have been listed in the table. The RBIs First Quarter Review of the Monetary Policy 2009-10 (July 28, 2009) did not announce any revisions in policy rates. While continuing the accommodative monetary stance, it however, noted that there could be a reversal of the expansionary measures to anchor inflation expectations and subdue inflationary pressures, if so warranted. The RBIs Second Quarter Review of Monetary Policy 2009-10 (October 27, 2009) made an overall assessment of the economy and indicated that the stance of monetary policy for the remaining period of 2009-10 would be to: (i) Maintain a monetary and interest rate regime consistent with price stability and financial stability, and supportive of the growth process (ii) Keep a vigil on the trends in inflation and be prepared to respond swiftly and effectively through policy adjustments to stabilize inflation expectations
(iii)
Monitor the liquidity situation closely and manage it actively to ensure that credit demands of productive sectors are adequately met while also securing price and financial stability.
The Second Quarter Review recognized the dilemma that while growth drivers warranted a delayed exit from the accommodative policy regime, inflation concerns called for an early exit. The RBI noted that a premature exit from the accommodative stance could derail the growth, but a delayed exit could also potentially engender inflation expectations. The following measures were announced in the Second Quarter Review of the Monetary Policy Statement: i. Liabilities of scheduled banks arising from transactions in CBLO (which were earlier exempted from CRR prescription), would be brought into the fold for maintenance of CRR with effect from the fortnight beginning November 21, 2009. ii. Keeping in view the large increase in credit to the commercial real estate sector, provisioning requirements to the sector classified as standard assets were increased from 0.40 to 1 per cent. iii. The forex swap facility to banks for tenor up to three months (available up to March 31, 2010) has been discontinued.
The RBI has in its Third Quarter Review of the Monetary Policy (January 29, 2010) indicated that its stance is shaped by three important considerations: i). The need to shift policy stance from managing the crisis to managing the recovery which implies reversal from the crisis-driven expansionary stance, thereby recognizing the need for carrying forward the process of exit further. ii). Though the inflationary pressures in the domestic economy stem predominantly from the supply side, consolidating recovery increases the risks of these pressures spilling over into a wider inflationary process. iii). Strong anti-inflationary measures, while addressing one problem may precipitate another by undermining the recovery, particularly by deterring private investment and consumer spending. Based on its assessment, the RBI changed different policy rates which have been stated in the tables attached before. The response of the monetary authority to the changing economic environment was also reflected in the indicative projections for macro-level parameters made by the RBI for 2009-10 in the Annual Policy Statement for the year and subsequent quarterly reviews.
MONETARY POLICY STANCE DURING 2010-11

In the latter part of the year 2009-10, in spite of having a good monsoon, the headline inflation remained high because of high levels of food inflation. Food inflation stood at 13.6% in December 2010 and hence the high levels of inflation in the same period. The heavy inflation in December 2010 could also be attributed to supply bottlenecks especially in vegetables, onions, tomatoes, fish, milk, eggs and fruits. The rise in purchasing power of people due to inclusive programmmes like MGNREGA (Mahatma Gandhi National Rural Employment Guarantee Act) might have partly contributed to the upward trend in inflation. The inflationary pressure persisted from both the domestic demand and higher global commodity prices. The average inflation from April-December 2010 was 9.4%. The RBI stated a clear shift in stance from managing the crisis to managing the recovery and announced the first phase of exit from the expansionary monetary policy in its Second Quarter Review of October 2009. As there were clear signs that the recovery was consolidating, it was felt that the main policy instruments were at levels more consistent with a fast recovering economy than a crisis economy and it was imperative therefore to carry forward the process of exit from an accommodative policy stance. Taking this consideration into account, during 2010-11 the RBI raised the policy rates six times whereby the repo rate was cumulatively increased by 175 basis points (bps) to stand at 6.5 per cent. Thus in 201011, the persistently high inflation above the comfort level of the RBI , together with growth buoyancy, necessitated that the monetary policy focus remain on containing inflation and inflationary expectations. The accommodative monetary policy which was pursued beginning mid-September 2008 instilled confidence in market participants, mitigated the adverse impact of the global financial crisis on the economy, and ensured that it started recovering ahead of most other economies. However, in view of the rising food inflation and the risk of it impinging on inflationary expectations, the Reserve Bank embarked on the first phase of exit from the expansionary monetary policy in October 2009 itself. By April 2010, available data suggested that the recovery was firmly in place, though inflationary pressures accentuated. Accordingly, both repo and reverse repo rates as well as the CRR were increased by 25 bps each. The monetary policy stance in April 2010 was guided by the following three considerations. First, the need to move in a calibrated manner in the direction of normalizing the policy instruments in a scenario where real policy rates were still negative. Second, the need to ensure that demand-side inflation did not become entrenched.
Third, the need to balance the monetary policy imperative of absorbing liquidity while ensuring that credit was available to both the Government and private sector. Significant developments took place subsequent to the announcement of the monetary policy in April 2010. Though recovery was consolidating, developments on the inflation front raised several concerns. The upward revision in administered fuel prices on 25 June 2010 was also expected to influence inflation in the months ahead. Accordingly, the repo and reverse repo rates were increased by 25 bps each on 2 July 2010. In the interests of consolidating and of more broadbased domestic recovery and with the then level of consumer price inflation in double digits, the First Quarter Review of the RBI (July 2010) upwardly revised the baseline projection of real GDP growth for the year to 8.5 per cent and raised the projection for WPI inflation for March 2011 to 6.0 per cent Consistent with this assessment, the repo rate was increased by 25 bps and reverse repo by 50 bps. The monetary policy actions were intended to moderate inflation by reining in demand pressures and inflationary expectations, maintain financial conditions conducive to sustaining growth, generate liquidity conditions consistent with more effective transmission of policy actions, and reduce the volatility of short-term rates in a narrower corridor. The RBI in its Third Quarter Review of the Monetary Policy (25 January 2011) indicated that its stance is shaped by four important considerations: Inflation is clearly the dominant concern. Even as the rate itself remains high, the reversal in the direction of inflation is striking. Primary food articles inflation has risen again sharply. Non-food articles inflation and fuel inflation are already at elevated levels. Non-food manufacturing inflation has remained sticky. There are signs of food and fuel price increases spilling over into generalised inflation. Second, there has been a sharp rise in global commodity prices which has heightened upside risks to domestic inflation. Third, growth has moved close to its pre-crisis trajectory even in the face of an uncertain global recovery. Fourth, the uncertainty with regard to global recovery has reduced.
OTHER INDICATORS OF SUCCESS OF MONETARY POLICY INDIA BUSINESS CONFIDENCE: In India, business confidence declined to 145.2 in July
of 2011 from 145.3 in April of 2011. In India, the NCAER (National Council of Applied Economic Research) - MasterCard Worldwide Index of Business Confidence measures the level of optimism that people who run companies have about the performance of the economy and how they feel about their organizations prospects. Survey incorporates four indicators: overall economic conditions six months from now, financial position of firms six months from now, investment climate and capacity utilisation level. Data is collected through personal interviews and questionnaires sent to a diverse range of businesses across various regions in India.
As can be seen from the figure above, the Business Confidence index crashed down to 80-90 level between Jan-09 to July-09. This was the time when inflation was at its lowest and recession set in due to the world economic crisis. However, with the RBIs continuous use of expansionary policy, the index went on increasing and even though in the current scenario, RBI is going for monetary tightening by increasing interest rates, yet the index stood at high levels. The interest rates for the years have been depicted in the below given graph and is followed by a graph denoting changes in GDP growth over the same period. One can see a period of very low interest rates which were kept as a policy measure by RBI to revive the economy out of recession and this was successful also as can be seen by the gradual increase of GDP growth. But the current monetary tightening is taking a toll on the economy as GDP totters in a downward direction with the latest figure being pegged at 6.9% on December 1, 2011.
RECOMMENDATIONS
1) Clearly there has been an easing of the overall inflationary situation even though the
recent spike in food prices is a cause for concern. On the other hand, the high growth that India has achieved this year is remarkable. As always with high growth, this is also a moment of opportunities. This is the time when we have to make sure that the economy builds up strengthsfiscal, infrastructural and moreso that not only do we improve our current standard of living, we also accumulate resources and create fiscal space for bad times that may come our way in the future. In short, a part of the current recovery must be stored away to build future resilience.
2)
Several initiatives should be taken not only to control inflation but protect the
vulnerable sections of Indias population from the ravages of inflation. The way this has to be handled is by developing stronger systems of food security for the poor, more effective systems of providing cheap fertilizer to small farmers, micro credit to poor households in rural and urban areas, and basic health support and other such services.
3)
It is important to stress that not all price increase should be met with Government
interventions. Prices rise and fall in response to changing demand and supply scenarios in the country. Prices are signals to consumers and producers to alter their behaviour in response to exogenous changes in the economy. It is not advisable for Government to step in and flatten out all these price fluctuations.
4)
During the course of the year, when inflation in some food commodities stabilized,
there was another spike in prices of another set of commodities, led by onions, cabbage, milk, and a couple of other products. While the government is often forced to use the blunt instrument of controlling aggregate demand in the economy through monetary and fiscal instruments, these price spikes should be treated as occasion to investigate the micro structure of markets, in particular the production and distribution of goods from farm and factory to retail store and consumer. While political compulsions sometimes oblige Government to take short-term measures like banning exports and changing tax rates to correct the price spikes, it is important to take a longer-run view and be restrained in the use of such interventions. We should use each such inflationary episode to try and locate and rectify the flaws in the system of production and marketing.
5)
Increasing
agriculture
production
and productivity is a necessary condition not
only for ensuring national food security, livelihood security, and nutritional security but also for sustaining the high levels of growth envisaged in the current Plan. However, with very little growth in area and marginal growth in yields of many crops during the last decade, increasing agricultural production remains a challenge. Concerted and focused efforts are required for addressing the challenge of stagnating productivity levels in agriculture. A holistic approach, simultaneously working on agricultural research, development, dissemination of technology, and provision of agricultural inputs such as quality seed, fertilizers, pesticides, and irrigation, would help achieve the critical levels of productivity needed. Further, effective coordination and monitoring of the on-going agriculture and allied sector programmes needs to be ensured for optimum results.
6)
It is known that once an economy begins to operate close to its capacity, the
investment and savings rate are no longer such effective drivers of GDP growth. Growth then depends much more on skill development and innovative activity in the country. Hence, the government should concentrate more on research and development in all the fields for the long-term development of the economy. 7.) Regarding Fiscal Deficit: Fiscal Deficit is the difference between total revenue and total expenditure of the government. It is an indication of the total borrowings needed by the government. While calculating the total revenue, borrowings are not included. Generally fiscal deficit takes place due to either revenue deficit or a major hike in capital expenditure. Capital expenditure is incurred to create long-term assets such as factories, buildings and other development. A deficit is usually financed through borrowing from either the central bank of the country or raising money from capital markets by issuing different instruments like treasury bills and bonds. Fiscal Deficit leads to Inflation The part of the fiscal deficit which is financed by borrowing from the RBI leads to an increase in the money stock. Some people hold the unsubstantiated belief that a higher money stock automatically leads to inflation since "more money chases the same goods". In an economy in which the output of some essential commodities cannot be increased, the increase in demand caused by a larger fiscal deficit will raise prices.
In order to relate high fiscal deficit to inflation, some economists believe that the portion of fiscal deficit, which is financed by obtaining funds from the Reserve Bank of India, directs to rise in the money stock and a higher money stock eventually heads towards inflation. An increase in the cost of production when aggregate demand remains constant is the prime cause of cost-push inflation (or supply side inflation). The supply shortfall when the factories do not have enough capacity to produce goods to cater the existing demand could be one example. The cost of production will increase when prices of input materials increase. Also, when labour wages increase more than the proportionate increase in their productivity, the cost per unit of output increases; leading the companies to pass on the higher cost of production to the end consumers. Fiscal Deficit affects the Supply side inflation therefore; RBIs monetary policies have a very limited role to play here. A few facts are mentioned below:2008-09 Average Rate of Inflation: 8.1% Fiscal Deficit: 6.04% 2009-10 Average Rate of Inflation: 3.9% Fiscal Deficit: 6.39% 2010-11 Average Rate of Inflation: 9.6% Fiscal Deficit: 5.10% 2011-12 Average Rate of Inflation: 9.4% Fiscal Deficit (estimated): 4.6% Hence it can be seen that fiscal deficit has a direct relation with the inflation. Therefore, primarily if fiscal deficit is increasing even though RBI is tight on its monetary policy to
control inflation, fiscal policy will create a negative impact and hence the inflation would increase. Further, as we were scanning through the different articles on supply-side inflation in India, we came across an article which recorded the statement of the current Governor of R.B.I., Dr. D. Subbarao. The article quoted Apart from flagging the need for a quantum leap in logistics from production centres in villages to consumption centres in towns, Subbarao criticised the Centre's subsidy scheme, saying there was a strong case for revisiting the subsidy regime. He blamed the ineffective public distribution system for increasing inflation and the Mahatma Gandhi National Rural Employment Guarantee Scheme and said the proposed food subsidy bill could raise fiscal deficit and stoke inflation further. The wages given to workers enrolled under the NREGS scheme are indexed to the Consumer Price Index and were increased 20% since February 2006. The CPI measures changes in the price level of consumer goods and services purchased by households. "The amount spent on subsidies should be diverted to capital formation. The direct transfer scheme is neat in concept, but exceedingly difficult in implementation. We need to be mindful of the potential deficiencies and correct them" he said. Subbarao's scathing comments on the Centre's policy comes on day one of a parliamentary session in which the government will propose doubling food subsidies to about Rs 70,000 crore to bolster its support among millions of poor Indians ahead of state elections. Almost 68% of the country's 1.2 billion population will be entitled for food grains once the bill is enacted that will significantly raise annual grain procurement demand even as the available marketed surplus would not increase in the same. Thus when inflation is due to supply side shocks, which is known as Cost Push Inflation, even RBIs policy initiatives would not be very successful.
CASE STUDY OF THE IMPACT OF INFLATION ON THE INDIAN AUTOMOBILE SECTOR
Through the inclusion of this data, we intend to show the impact of inflation on a particular sector, the automobile. As is clear from the data, for the different categories of automobiles, the numbers sold is given between the period 2008-09 to 2010-11. We have calculated the year-on-year growth between 2008-09 and 2009-10 and for 2009-10 and 2010-11.Then we calculated the growth for these two y-on-y growths. The results showed that there was a negative growth for the passenger vehicle and commercial vehicle segments whereas a robust growth in the three wheelers and two wheelers category. The reasons which could be attributed for this trend are: 1. The petrol prices have been on a continuous increase due to global oil price rise and the demand continues to surge. Hence, consumers have stopped buying passenger vehicles and even commercial vehicles sales would have gone down because of the surging fuel prices. More and more people are shifting to the public transportation system (autos, etc) and hence increase in its price. Also, the middle class people, instead of buying a car would prefer sticking to two-wheelers because of a better fuel efficiency. 2. The current trend shows an increase in the price of steel which is the raw material for vehicles. This leads to increase in price of the overall vehicle and hence consumer is demotivated and does not buy the product. This is a case of supply side cost push as the prices of steel are rising because of soaring prices of their raw materials at international level and thus low supply and so high prices occur. The manufacturers of
automobiles transfer these extra costs onto the customers by increasing prices and customers retaliate and there is reduction in sales. Both these points suggest that even though the RBI might be pursuing the right monetary policies (like to restrict inflation currently by increasing policy rates), yet extraneous factors like global prices or supply-side restraints or even the spending policies of the Government might reverse the effect of the RBI initiatives or if not reverse, at least restrict its impact. As a conclusion, it could be said that the ultimate policy objective is the higher level of well-being for the population, but a conflict arises in the means of achieving it by higher growth or by lower inflation. There is a trade-off involved and both cannot be achieved together. A tightening of monetary policies may achieve lower inflation but only at the cost of growth. The policy-maker needs to find a correct balance between contractionary and expansionary policies to maximise the well being of its people. In the current scenario, the monetary tightening being pursued by the RBI is being opposed by the Industry because the contractionary policy is neither able to handle inflation well nor is it helping boost the economy is what they allege. But the fact of the matter is that RBI is not just a policy making body but it has some responsibilities, duties, principles and ethics to uphold. In the aftermath of the recent stint with recession in the U.S.A. which was an after-effect of the malfunctioning of the banking sector also, we saw how the greed of some people can destroy the future of so many nations and that of millions of people. Hence, sometimes when it might appear that the policies are unable to handle the situation well and they appear to be restrictive, it might be just that they are preparing grounds for a better future of a healthy economy which has a robust growth. The R.B.I. as a policy making body on monetary issues does just the same thing. With the support of the Government, it acts for the greater good of the greater number and not vested interests of a particular cartel.
REFERENCES
BOOKS: The Economic Survey Of India 2008-09 The Economic Survey Of India 2009-10 The Economic Survey OF India 2010-11 The Indian Commodity Book 2012 Inflation, Investment and Growth: The Role of Macroeconomic Policy in India by Patnaik, Ila and Joshi, D.K. , 1998.
INTERNET: www.rbi.org.in www.articles.economictimes.indiatimes.org www.siamindia.com www.planningcommission.nic.in www.tradingeconomics.com www.google.co.in www.theteamwork.com/articles/2016-2101-indian-government-current-monthlyannual-inflation-rate.html

RBI monetary policy effectiveness containing inflation

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RBI'S MONETARY POLICY INITIATIVES SINCE 2008-09 AND ITS EFFECTIVENESS IN CONTAINING INFLATION

RBIS MONETARY POLICY INITIATIVES

SINCE 2008-09 AND ITS EFFECTIVENESS IN CONTAINING INFLATION

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

RESERVE BANK OF INDIA

WHOLESALE PRICE INDEX

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

Primary Articles Fuel, Power, Light and Lubricants Manufactured Products

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

INFLATION TREND IN INDIA

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

INFLATION IN THE PRIMARY SECTOR: AGRICULTURE

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

INFLATION IN THE SECONDARY SECTOR: INDUSTRY FINANCING AND INVESTMENT

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

INDEX OF INDUSTRIAL PRODUCTION (IIP)

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

INFLATION IN THE TERTIARY SECTOR: THE SERVICE SECTOR

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

MONETARY DEVELOPMENTS EMERGING TRENDS IN 2008-09

Update on monetary policy stance during 2009-10:

The monetary policy stance for 2009-10 aims to:

ACTUAL MONETARY POLICY STANCE DURING 2009-10

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

MONETARY POLICY STANCE DURING 2010-11

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

and productivity is a necessary condition not

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

CASE STUDY OF THE IMPACT OF INFLATION ON THE INDIAN AUTOMOBILE SECTOR

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

INTERNET: www.rbi.org.in www.articles.economictimes.indiatimes.org www.siamindia.com www.planningcommission.nic.in www.tradingeconomics.com www.google.co.in www.theteamwork.com/articles/2016-2101-indian-government-current-monthlyannual-inflation-rate.html

BIRLA INSTITUTE OF MANAGEMENT TECHNOLOGY, GREATER NOIDA

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