CENTRAL BANKING IS CURRENTLY DEALING WITH INFLATION INTRODUCTION

On inflation front, RBI has continued with its tough stance (RBI Statement) against inflation. However, the guidance given on inflation this time has been more optimistic than last time. In its Policy review statement, RBI has mentioned its expectations regarding softening of inflationAs monetary policy operates with a lag, the cumulative impact of policy actions should now be increasingly felt in further moderation in demand and reversal of the inflation trajectory towards the later part of 2011-12 Inflationary pressures are expected to ease towards the later part of 2011-12. Stabilization of energy prices and moderating domestic demand should facilitate this process Views on normal monsoon and a record production of grains Monsoon rains so far have been normal. The first advance estimates for the 2011-12 kharif season point to a record production of rice, oilseeds and cotton, while the output of pulses may decline. This might be taken as an expectation that food prices might decrease However, it also expects that for the coming few months, inflation will remain high. It also gives certain factors which are likely to continue adding to inflationary pressures .there is still an element of suppressed inflation. Though global oil prices have moderated, the pass-through to domestic prices remains incomplete. Also, current administered electricity prices are yet to reflect increase in input prices, even as many states have initiated increases. Food inflation is at neardouble digit levels, despite normal monsoons, underlining the fact that it is being driven by structural demand-supply imbalances and cannot be dismissed as a temporary phenomenon. The inflation momentum, reflected in the de-seasonalised sequential monthly data, persists.

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WHY DO WE NEED TO WORRY ABOUT INFLATION? We need to be concerned about inflation as it has adverse impact on the real economy. First, high and persistent inflation imposes significant socio-economic costs. Given that the burden of inflation is disproportionately large on the poor, high inflation by itself can lead to distributional inequality. Therefore, for a welfare-oriented public policy, low inflation becomes a critical element for ensuring balanced progress. Second, high inflation distorts economic incentives by diverting resources away from productive investment to speculative activities. Third, inflation reduces households saving as they try to maintain the real value of their consumption. Consequent fall in overall investment in the economy reduces its potential growth. Fourth, as inflation rises and turns volatile, it raises the inflation risk premia in financial transactions. Hence, nominal interest rates tend to be higher than they would have been under low and stable inflation. Fifth, if domestic inflation remains persistently higher than those of the trading partners, it affects external competitiveness through appreciation of the real exchange rate. Sixth, as inflation rises beyond a threshold, it has an adverse impact on overall growth. The Reserve Banks current assessment suggests that the threshold level of inflation for India is in the range of 4-6 per cent1. If inflation persists beyond this level, it could lower economic growth over the medium-term. These costs, therefore, necessitate monetary policy response to control inflation. HOW DID THE INFLATION DYNAMICS CHANGE? It is important to appreciate the background in which the inflation surge has occurred. The current phase of high inflation followed the global financial crisis, which affected the Indias economy, though not with the same intensity as advanced countries. Managing inflation in an economy which is recovering from a downturn is much more complex because of associated uncertainties than managing inflation under normal conditions.

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PRELUDE TO CURRENT INFLATION SURGE In the initial phase of the crisis, it appeared that emerging market economies (EMEs) were better positioned to weather the storm created by the global financial meltdown on the back of their substantial foreign exchange reserve cushion, improved policy frameworks and generally robust banking sector and corporate balance sheets. However, any hope about EMEs escaping unscathed could not be sustained after the failure of Lehman Brothers in September 2008 which triggered global deleveraging and heightened risk aversion. Eventually, EMEs were also adversely affected by the spillover effects: first through contraction in world trade and then from reversal in capital flows. India, though initially somewhat insulated from the global developments, was eventually impacted significantly by the global shocks through all the channels trade, finance and expectations channels. In response, the Reserve Bank swiftly introduced a comprehensive range of measures to limit the impact of the adverse global developments on the domestic financial system and the economy. The Reserve Bank, like most central banks, took a number of conventional and unconventional measures to augment domestic and foreign currency liquidity, and sharply reduced the policy rates. In a span of seven months between October 2008 and April 2009, there was unprecedented policy activism. For example: (i) the repo rate was reduced by 425 basis points to 4.75 per cent, (ii) the reverse repo rate was reduced by 275 basis points to 3.25 per cent, (iii) the cash reserve ratio (CRR) of banks was reduced by a cumulative 400 basis points of their net demand and time liabilities (NDTL) to 5.0 per cent, and (iv) the total amount of primary liquidity potentially made available to the financial system was over ` 5.6 trillion or over 10 per cent of GDP. The Government also come up with various fiscal stimulus measures. In October 2009, it was not easy to exit from the excessively accommodative monetary policy stance for two main reasons. First, the year-on-year headline WPI inflation had just barely turned positive and was entirely driven by food inflation. Industrial production had started to pick up but exports were still declining. Hence, recovery was not assured. Second, globally, most central banks were in favour of continuing stimulus. On the other hand, domestically, consumer price inflation was high, households inflation expectations were rising and surplus liquidity was substantial as reflected in the Reserve Banks Liquidity Adjustment Facility (LAF) window. These developments had inflationary consequences.
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In its Second Quarter Review of Monetary Policy for 2009-10, the Reserve Bank after wider consultations provided the arguments for and against beginning reversal of monetary easing. On balance of considerations, the Reserve Bank judged that the time was appropriate to sequence the exit in a calibrated way so that while the recovery process was not hampered, inflation expectations remained anchored. The exit process thus began with the closure of the special liquidity facilities instituted during the crisis. This amounted to withdrawal of potential liquidity to the tune of ` 1.7 trillion

CONTROLLING INFLATION Controlling Inflation forms a significant part of the economic activities of a nation. Inflation is an economic condition characterized by a general rise in the prices. Thus, controlling Inflation is important as unrestrained increase of the prices may culminate in Hyperinflation, and an excessive fall in the prices may lead to Deflation. Both the situations are not healthy and sound for the overall growth and development of a country's economy. In fact, keeping a strong control over Inflation has turned out to be one of the primary objectives of the governments of different countries across the globe. To this effect, efficacious economic policies are being formulated, which mainly concentrate on the fundamental causes of Inflation in an economy, and try to improvise methods to keep the inflationary conditions under control. For instance, if the primary reason for inflation in a nation is the excessive demand for goods and services, then the economic policy on governmental level should find out the causes of such unnecessary rise and undertake measures to decrease the overall level of collective demand. Sometimes, if it is seen that Cost-Push Inflation is responsible for the rise in the demand for goods and services, then the cost of production must be checked, to handle the inflation-related problems.

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POLICIES IN DEALING WITH CONTROL OF INFLATION Monetary policy 2.1 The concept of monetary policy Monetary policy is the process a government, central bank, or monetary authority of a country uses to control (i) the supply of money, (ii) availability of money, and (iii) cost of money or rate of interest to attain a set of objectives oriented towards the growth and stability of the economy. Monetary theory provides insight into how to craft optimal monetary policy. Monetary policy is referred to as either being an expansionary policy, or a contractionary policy, where an expansionary policy increases the total supply of money in the economy, and a contractionary policy decreases the total money supply. Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates, while contractionary policy involves raising interest rates to combat inflation. The primary tool of monetary policy is open market operations. This entails managing the quantity of money in circulation through the buying and selling of various financial instruments, such as treasury bills, company bonds, or foreign currencies. All of these purchases or sales result in more or less base currency entering or leaving market circulation. Usually, the short term goal of open market operations is to achieve a specific short term interest rate target. In other instances, monetary policy might instead entail the targeting of a specific exchange rate relative to some foreign currency or else relative to gold.

2.2 Various tools in the monetary policy to control inflation: Repo (Repurchase) Rate Repo rate is the rate at which banks borrow funds from the RBI to meet the gap between the demands they are facing for money (loans) and how much they have on hand to lend.
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If the RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate; similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate. Implications on inflation: If the inflation is rising, reserve bank increases the repo rate so that other banks reduce their borrowings which are further used for giving loans. Thus in turn reduces the money supply and decreases liquidity. Thus inflation can be controlled. Also the increase in repo rate fuels the increase in interest rates as the cost of borrowing increases. This, leads to increase in savings and decrease in investment borrowings. Reverse Repo Rate This is the exact opposite of repo rate. The rate at which RBI borrows money from the banks (or banks lend money to the RBI) is termed the reverse repo rate. The RBI uses this tool when it feels there is too much money floating in the banking system. Implications on inflation: If the reverse repo rate is increased, it means the RBI will borrow money from the bank and offer them a lucrative rate of interest. As a result, banks would prefer to keep their money with the RBI (which is absolutely risk free) instead of lending it out (this option comes with a certain amount of risk) Consequently, banks would have lesser funds to lend to their customers. This helps stem the flow of excess money into the economy. Thus, this will control inflation. Reverse repo rate signifies the rate at which the central bank absorbs liquidity from the banks, while repo signifies the rate at which liquidity is injected. CRR Also called the cash reserve ratio, refers to a portion of deposits (as cash) which banks have to keep/maintain with the RBI. This serves two purposes. It ensures that a portion of bank deposits is totally risk-free and secondly it enables that RBI
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control liquidity in the system, and thereby, inflation by tying their hands in lending money. Implications on inflation: By increasing the CRR reserve bank reduces the money supply and thus keeps a check on the inflation.

SLR Besides the CRR, banks are required to invest a portion of their deposits in government securities as a part of their statutory liquidity ratio (SLR) requirements. What SLR does is again restrict the banks leverage in pumping more money into the economy. Implications on inflation: SLR has the same implication as CRR has. If SLR is increased the banks have to park more of their funds in the government securities, reduce lending which in turn reduces the money supply and hence the inflation. 2.3 Various types of monetary policies: 2.3.1 Inflation targeting Under this policy approach the target is to keep inflation, under a particular definition such as Consumer Price Index, within a desired range. The inflation target is achieved through periodic adjustments to the Central Bank interest rate target. The interest rate used is generally the interbank rate at which banks lend to each other overnight for cash flow purposes. Depending on the country this particular interest rate might be called the cash rate or something similar. The interest rate target is maintained for a specific duration using open market operations. Typically the duration that the interest rate target is kept constant will vary between months and years. This interest rate target is usually reviewed on a monthly or quarterly basis by a policy committee.
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It is currently used in Australia, Canada, Chile, Colombia, the Eurozone, New Zealand, Norway, Iceland, Philippines, Poland, Sweden, South Africa, Turkey, and the United Kingdom. 2.3.2 Price level targeting Price level targeting is similar to inflation targeting except that CPI growth in one year is offset in subsequent years such that over time the price level on aggregate does not move. 2.3.3 Monetary aggregates In the 1980s, several countries used an approach based on a constant growth in the money supply. This approach was refined to include different classes of money and credit (M0, M1 etc). In the USA this approach to monetary policy was discontinued with the selection of Alan Greenspan as Fed Chairman. This approach is also sometimes called monetarism. While most monetary policy focuses on a price signal of one form or another, this approach is focused on monetary quantities. 2.3.4 Fixed exchange rate This policy is based on maintaining a fixed exchange rate with a foreign currency. There are varying degrees of fixed exchange rates, which can be ranked in relation to how rigid the fixed exchange rate is with the anchor nation. Under a system of fiat fixed rates, the local government or monetary authority declares a fixed exchange rate but does not actively buy or sell currency to maintain the rate. Instead, the rate is enforced by non-convertibility measures (e.g. capital controls, import/export licenses, etc) Under a system of fixed-convertibility, currency is bought and sold by the central bank or monetary authority on a daily basis to achieve the target exchange rate. This target rate may be a fixed level or a fixed band within which the exchange rate may fluctuate until the monetary authority intervenes to buy or sell as necessary to maintain the exchange rate within the band. (In this case, the fixed

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exchange rate with a fixed level can be seen as a special case of the fixed exchange rate with bands where the bands are set to zero.) 2.3.5 Gold standard The gold standard is a system in which the price of the national currency as measured in units of gold bars and is kept constant by the daily buying and selling of base currency to other countries and nationals. (I.e. open market operations cf. above). The selling of gold is very important for economic growth and stability. The gold standard might be regarded as a special case of the "Fixed Exchange Rate" policy. And the gold price might be regarded as a special type of "Commodity Price Index".

THE MONETARY POLICY USED BY INDIA: India uses multiple indicator approach as their monetary policy. In this policy, the government keeps a check and controls the value of various indicators such as CPI, WPI etc. Fiscal policy: The concept of fiscal policy: In economics, fiscal policy is the use of government expenditure and revenue collection to influence the economy. Fiscal policy can be contrasted with the other main type of economic policy, monetary policy, which attempts to stabilize the economy by controlling interest rates and the supply of money. The two main instruments of fiscal policy are government expenditure and taxation. Changes in the level and composition of taxation and government spending can impact on the following variables in the economy: Aggregate demand and the level of economic activity;
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The pattern of resource allocation; The distribution of income. Fiscal policy refers to the overall effect of the budget outcome on economic activity. The three possible stances of fiscal policy are neutral, expansionary, and contractionary. Fiscal policy can controls/prevents inflation: There are two significant differences between fiscal policies designed to control already existing inflation and those designed to prevent inflation from afflicting an economy which at the time is free of inflation. The first difference relates to time horizon and the speed at which a policy measure is carried out. The second relates to the size of the change required in the relevant variables e.g. government expenditure, taxes, etc. Policies designed to control inflation have to have an impact now. They must be fast acting showing their results in a matter of months. This in turn may require big reduction in government expenditure, large increases in taxes, huge amounts of domestic borrowing etc. Given these measures successfully implemented over a short period of time aggregate demand will decrease and the trend of prices to rise will be checked.

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HOW DOES FISCAL POLICY CONTROL INFLATION: Reduction in Public Expenditure It is only when it comes to the public goods and the welfare activities of the government that reduction in government expenditure becomes a real possibility. But the actual scope of such reduction depends on the historical path followed by (the increase in) government expenditure. Modern day governments have shown little ability to reduce expenditure on education and health care. For a developing country like India reduction in expenditure on education and health care is still the less appealing. The most a developing country can manage to do is to prevent expenditure on these items from increasing further. Reducing the current levels of expenditure on education and health care are no where a real option. In fact any attempt to do so would be economically disastrous and politically suicidal for the regime. Increase in Tax Revenues Increasing the Supply of Goods and Services Supply of goods and services can be increased to match the demand by spending money in a way that increases supply of goods and services. This spending does not have to be done by the government itself, at least not all of it. Tax reduction that encourages private investment may serve the same purpose. Lowering corporation taxes and lowering or scrapping capital gains taxes, even scaling down the income taxes may boost production by increasing the incentive to work and the incentive to save. Another possible measure is to restructure the subsidies, if any, in favour of the intermediate industries whose products are needed for expanding the production of consumer goods. Building the infrastructure --- roads, bridges, irrigation systems, electricity and telecommunication, etc. --- at public cost and making them available to the private sector at affordable prices has also been a policy. They are auctioned by Reserve Bank of India at regular intervals and issued at a discount to face value. On maturity the face value is paid to the holder. The rate of discount and the corresponding issue prices are determined at each auction. When liquidity is tight in the economy, returns on Treasury Bills
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sometimes become even higher than returns on bank deposits of similar maturity. Any person in India including Individuals, Firms, Companies, Corporate bodies, Trusts and Institutions can purchase Treasury Bills. Treasury Bills are eligible securities for SLR. Treasury Bills are available for a minimum amount of Rs.25,000 and in multiples of Rs. 25,000 thereafter. They are available in both Primary and Secondary market. Type of Treasury Bills: At present, RBI issues T-Bills for three different maturities: 91 days, 182 days and 364 days. The 91 day T-Bills are issued on weekly auction basis while 182 day TBill auction is held on Wednesday preceding non-reporting Friday and 364 day TBill auction on Wednesday preceding the reporting Friday Monetary policy v/s Fiscal policy Time frame required to control inflation: As far as the monetary policy is concerned, it takes some time before it actually can influence inflation. The reason for this is that, once the rates are changed, it does not immediately affect the investing and saving trends amongst the people. However, as fiscal policy directly involves controlling the taxes collected by the people, changing the government expenditure, auction of bonds etc, thus the money supply is directly controlled and this significantly and very rapidly controls inflation. Long term effect of these polices: In long run an excessive exercise of monetary policy by increasing the interest rates reduces the investment and hence the demand. This in turn affects the growth of the economy. But in fiscal policy only the excess money which causes high demand is removed from the market through taxes, bonds etc. This does not affect the growth of the economy.
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Long term policies to control inflation: Control of wages; Direct wage controls - incomes policies Incomes policies (or direct wage controls) set limits on the rate of growth of wages and have the potential to reduce cost inflation. The Government has not used such a policy since the late 1970s, but it does still try to influence wage growth by restricting pay rises in the public sector and by setting cash limits for the pay of public sector employees. In the private sector the government may try moral suasion to persuade firms and employees to exercise moderation in wage negotiations. This is rarely sufficient on its own. Wage inflation normally falls when the economy is heading into recession and unemployment starts to rise. This causes greater job insecurity and some workers may trade off lower pay claims for some degree of employment protection. Long-term labor policies to control inflation Labour market reforms The weakening of trade union power, the growth of part-time and temporary working along with the expansion of flexible working hours are all moves that have increased flexibility in the labour market. If this does allow firms to control their labour costs it may reduce cost push inflationary pressure. Supply-side reforms If a greater output can be produced at a lower cost per unit, then the economy can achieve sustained economic growth without inflation. An increase in aggregate supply is often a key long term objective of Government economic policy. In the diagram below we see the benefits of an outward shift in the long run aggregate supply curve. The equilibrium level of real national income increases and the average price level remain relatively constant. Controlling inflation by giving subsidy to the poor:

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Last year (2009), The government, visibly concerned over rising food inflation, has said that it will take steps to arrest rising prices of essential food items in the country. Finance Minister Pranab Mukherjee said that the government is already providing subsidy to the poor people of the society through the public distribution system (PDS) and strengthening the same to ensure its proper utilization. Inflation Hedging Inflation Hedge is an investment with intrinsic value such as oil, natural gas, gold, farmland, and to a lesser degree commercial real estate. Typically most hard assets are an excellent inflation hedge. In general, commodities/hard assets are negatively correlated to both stocks and bonds. In other words, when stocks and bonds decline, commodities tend to appreciate. In addition, during periods of high inflation/negative real interest rates equities and bonds do poorly.

WHAT ARE THE MAIN DIFFICULTIES THE CENTRAL BANK MIGHT ENCOUNTER IN ATTEMPTING TO REDUCE THE RATE OF INFLATION?

The Central Bank can use various different methods for reducing inflation. At the moment, the Bank Of England primarily uses changing the rate of interest (base rate) to keep inflation within the govt target of 2% + / - 1 The Monetary Policy Committee meet every month to set interest rates based on future predictions of inflation. Monetary policy is pre-emptive; this means they try and reduce inflationary pressures before they build up. To reduce inflation the MPC can increase the base interest rate. This will lead to a general rise in interest rates. This will make borrowing more expensive and savings more attractive, therefore consumption and investment will fall, causing AD to increase at a slower rate and help reduce inflation.

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The first difficulty is predicting future inflation trends. According to current economic trends there may be no threat of rising inflation and therefore the MPC will leave interest rates unchanged. However, if there is an unexpected increase in AD, (e.g. due to rising house prices or higher confidence) inflation may increase before they have time to increase interest rates. This problem may be exacerbated by the problem of time lags. If interest rates are increased, it may be a while before this has an effect of reducing AD. For example, firms will not stop current investment projects, but higher interest rates may deter future investment projects. Higher interest rates may also be ineffective in reducing inflation if other components of AD are rising. E.g, in the late 1980s, higher interest rates were initially ineffective in reducing AD because consumer confidence was very high and people were still willing to borrow despite the higher interest rates. If there is a supply side shock in the economy it may prove more difficult to reduce inflation because higher interest rates will cause an even bigger fall in real GDP

If there was a significant increase in the price of oil LRAS would shift to the left causing higher inflation and lower Real GDP. To reduce inflation using interest rates would cause lower AD and therefore a bigger fall in Real GDP to Y3, this might be politically unacceptable.

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IN INDIA, HIGH INFLATION IS A BIG CONCERN. HOW DO YOU THINK INDIAN GOVERNMENT CAN REIN IN INFLATION TO APPROPRIATE LEVELS?

Inflation management is going to be very tough. It is going to be an issue which would be persistent for a while. There are both demand and supply side issues which are confronting the Indian inflation problem. On the one side, you have rising demand because of the growth and on the other side the supply factors have not kept pace. The rising demand and supply deficiencies in various sectors is leading to a rise in prices. When you look at other countries like China, they have managed to keep inflation low during the high growth phase because supply was never really a problem. They always created additional capacities and it is only now when the global food prices have risen, inflation has become a problem in China. Unlike China, India has many supply-side issues and the result is this spiraling inflation. The Indian Governments policy should focus on increasing supplies. Tampering with demand would lead to lower growth. Over a medium to long term, we have to plan in such a way that the supplies are sufficient to keep pace with demand. In the short term, we have no other option but to soften demand through monetary tightening. RBI HAS RISEN RECENTLY RAISED INTEREST RATES. IS THAT ENOUGH TO CONTROL INDIAS INFLATION PROBLEM? RBI can only control inflation which comes from demand factors. By raising interest rates it tries to lower money supply in the overall economy. This leads to an overall affect of lowering the demand in the country. Also monetary transmission takes a long time to materialize. The expectation that RBIs rate hike of 50 bps would suddenly lower inflation is not possible. Globally, central banks have kept interest rates very low. But banks didnt lower the rates as much due to high risk and funding pressures. Monetary transmission has not been efficient in this crisis. We see similar situation in India as well. When RBI lowered rates in wake of crisis the rates did not come down as much. And now when it raised rates starting from March-10, it is only now the banks have followed.
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In March 2011, RBI is expected to raise the interest rates again. RBI has been ahead of most other Central Banks by raising interest rates and doing away with the unconventional monetary policies put in place after the crisis in 2008. In India, inflation has become a structural problem rather than a cyclical problem. There are many factors responsible for inflation and monetary policy alone cannot solve the problem. Since India started growing in 1990s, there is a problem of not achieving inclusive growth. As a result inequality has risen. We compare our macroeconomic indicators like GDP growth with peers from the BRIC nations. But on the social economic indicators, some of our peers are poor African countries. So the Government has started several social development programmes like NREGA etc. However, some Economists believe that these programmes actually increase aggregate demand and have stoked inflation. Hence, we have a problem of achieving inclusive growth and increasing the overall supplies which are already under pressure. IS INDIAS CURRENT ACCOUNT DEFICIT AN ISSUE OF CONCERN? Any deficit is a problem, whether fiscal or current account. If expenditures are more than income, obviously you are under stress. At a country level, persistent current and fiscal deficit is a major problem to the growth of an economy. As India is a developing economy, the expenditures may be higher than incomes. But the critical question is how are the expenditures being financed? If it is largely financed by the short term flows, then it is a reason to be worried. These sources can die anytime and so you are continuously under pressure. The governance crisis, the inflation problem etc. further complicate the problem. Many developed countries like USA, UK, and Greece had deficits and now are under stress with deeper problems. In the past, the South East Asian and Latin American economies had faced similar problems. Suddenly there is one particular event that triggers a crisis resulting in the funds drying up and causing an economic collapse. It requires a very small event to trigger something bigger. So we cant ignore any of these deficits. Markets dont take persistent deficits kindly. They may be praising you for some time, but they may easily desert you. The policy makers have to be cautious. I really dont know how Current Account Deficit would affect us but it is emerging as a major risk. If the FIIs pull out funds in a short time, then managing the Current Account Deficit will be a major

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problem. The Current Account Deficit may not act as a trigger for a crisis but it can amplify when any crisis occurs.

FDI IN RETAIL TO HELP CONTROL INFLATION: RBI Reserve Bank of India Governor D Subbarao on Friday said that foreign direct investment (FDI) in multi-brand retail will help in bringing down inflation. Certainly it (FDI in multi-brand retail) would help improve supply chain and we hope it should also contribute to reducing inflation, Subbarao told reporters on the sidelines of a function in Chandigarh. Subbarao said 51 per cent FDI in multi-brand retail would attract foreign capital into the country. It is a visible measure (taken by the government) that will bring right capital into the country, he said. The RBI Governor said the decision of the Cabinet allowing 51 per cent FDI in multi-brand retail would improve logistics, contain inflation and improve quality of life of over 50 per cent of countrys population. In his speech, Subbarao described rising inflation as a problem of success and made a strong case for raising farm productivity to address the root cause of food inflation, which has been hovering around 10 per cent. To build forward and backward linkages, there is need to invest in rural infrastructure and the supply chain, he said. The supply-demand gap in the food sector is, in part, a problem of success a consequence of a shift in dietary habits from cereal to protein-based foods reflecting rising income, especially rural incomes, he said. While the food inflation marginally came down to 9.01 per cent for the week ended November 12, the headline inflation was 9.73 per cent in October. Delivering the Haksar Memorial Lecture at Centre for Research in Rural and Industrial Development, he made constant comparisons between India and China, and expressed concern over the sluggish growth of the Indian manufacturing sector, while the latter was fast surging ahead.

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RBI CREDIT POLICY: REPO RATE UNCHANGED, CRR CUT BY 0.5 PER CENT
The Reserve Bank of India (RBI) on Tuesday injected Rs.32,000 crore into the system by lowering the Cash Reserve Ratio (CRR) by half-a-percentage point but kept the short-term lending rate unchanged in view of persisting inflationary concerns. "Based on the current inflation trajectory, including consideration of suppressed inflation, it is premature to begin reducing the policy rate," RBI Governor D Subbarao said while unveiling the third quarterly monetary policy review. With additional liquidity by CRR cut, there is a possibility that banks may reduce the interest rate to attract borrowers. Projecting a lower growth of 7 per cent for 2011-12, the Reserve Bank said the policy actions are meant to "mitigate downside risks to growth" and anchor inflationary expectations. The CRR, the amount of deposits the banks are required to keep with RBI in cash, has been reduced to 5.5 per cent from 6 per cent with effect from January 28, releasing Rs.32,000 crore in the system to ease the liquidity problems. The shortterm lending rate (repo) has been kept unchanged at 8.5 per cent. The policy said through the multiplier effect, additional credit to the tune of Rs.1.6 lakh crore would be generated in the system over a period of time. The stock market reacted positively to the policy announcement and the banking stocks, in particular, shot up. The RBI retained the repo or the short-term lending rate at 8.5 per cent while making it clear that any cut in it will only happen after moderation in inflation. Subbarao said, "Even as inflation remains elevated, despite moderation, downside risks to growth have increased. The growth-inflation balance of the monetary policy stance has now shifted to growth".

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He further said slippage on fiscal deficit, crude prices and rupee depreciation are key challenges for inflation, which after remaining near double digit for almost two-years, came down to 7.5 per cent in December 2011. The central bank expects the headline inflation to moderate to 7 per cent by March, but there is concern over the persistently high prices of non-food manufacturing ites. The Chairman of Prime Minister's Economic Advisory Panel, C Rangarajan, said RBI has taken a "wise decision" and it would lead to softening of interest rate. "The improvement in liquidity condition will automatically have effect on interest rate. Improvement in liquidity condition will lead to softening of interest rate," he said. On CRR cut, RBI said, "Persistence of tight liquidity conditions could disrupt credit flow and further exacerbate growth risks...CRR is the most effective instrument for permanent liquidity injections..." It indicated that future rate actions can see more lowering on the front. Apart from easing liquidity pressures, the RBI said the policy actions are aimed at mitigating downside risks to growth and anchoring medium term inflation expectations. Liquidity deficit has been consistently above the RBI's comfort level for the past three months, with banks' borrowing from the overnight borrowing going up to Rs.1.20 lakh crore this month.

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INDIA INFLATION RATE The inflation rate in India was last reported at 9.34 percent in November of 2011. From 1969 until 2010, the average inflation rate in India was 7.99 percent reaching an historical high of 34.68 percent in September of 1974 and a record low of 11.31 percent in May of 1976. Inflation rate refers to a general rise in prices measured against a standard level of purchasing power. The most well known measures of Inflation are the CPI which measures consumer prices, and the GDP deflator, which measures inflation in the whole of the domestic economy. This page includes: India Inflation Rate chart, historical data and news.

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CONCLUSION First, inflation in India has remained elevated and persistent over 18 months now. The inflation path was influenced by a number of domestic and international supply shocks. Monsoon failure in 2009-10 and sharp increase in international fuel and commodities prices accentuated domestic inflationary pressures. Second, the evolution of inflation so far from its low level in October 2009 can be seen in four phases: first, driven by food prices and then by fuel and industrial raw material prices, and finally spilling over to a generalised inflation process. In fact, inflation was on a declining trajectory between August and November 2010 before reversing course in December and getting generalised. Third, monetary policy response began early in October 2009 in anticipation of the likely path of the inflation trajectory as also on consideration of its source and composition. The background of calibrated monetary policy response is important as policy was reversed from its highly stimulative stance with policy interest rates at the historically lowest levels and liquidity was high. During this period, the global economy remained mired in uncertainties and domestic recovery was also not assured. Fourth, the initial rounds of monetary policy response was in the nature of normalisation from an excessively stimulative stance in a non-disruptive manner. The policy response was calibrated to the domestic growth-inflation dynamics. As growth took hold and inflation became more generalised, monetary policy response was strengthened. Initially, monetary transmission was weak as systemic liquidity was in surplus. But once liquidity turned into deficit in July 2010, monetary transmission improved. Fifth, since October 2009, the cash reserve ratio (CRR) has been raised by 100 basis points. The policy repo rate has been raised by a cumulative 325 basis points. As the liquidity in the system transited from surplus to deficit, the effective tightening has been of the order of 475 basis points. Thus, the cumulative monetary policy action would have the desired impact on inflation. It is expected that inflation would moderate towards the later part of 2011-12 and come down to around 7 per cent by the end of the year. The current monetary stance remains antiinflationary. Sixth, inflation imposes real costs which are borne disproportionately by the different segments of the economy. Prolonged high inflation, even if originating from the supply side, could give rise to increased inflation expectations and cause
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general prices to rise. As inflation is inimical to growth, it becomes necessary for monetary policy to respond to contain inflation and anchor inflationary expectations. Seventh, the medium-term objective of the Reserve Bank is to bring down inflation to 3.0 per cent consistent with Indias broader integration into the global economy. In this direction, monetary policy aims to contain perceptions of inflation in the range of 4.04.5 per cent with a particular focus on the behaviour of the non-food manufacturing component. This objective is consistent with the estimated threshold level of inflation of 46 per cent suggesting the absence of a new normal for inflation in India.

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