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I would like to mention a few more causes behind increasing inflation...A sharp hike in borrowing and lending rates took place in recent months. With inflation up and the RBI saying it will take “all the necessary monetary measures”, further hikes in interest rates could come. But will raising interest rates bring inflation under control? Does India have the markets and institutional framework in which raising interest rates is an effective instrument for inflation control? Does India have a central bank that has learned how to conduct monetary policy in an open market economy? The answer to these questions is: No. In this sphere, India lags behind modern practices.
One striking feature of monetary policy in India has been the element of surprise. When inflationary pressures appeared in 2004, central banks all over the world responded by controlling inflationary expectations. The US Federal Reserve Bank raised the ‘federal funds rate’ in a calibrated manner, 17 times by 25 basis points each since July 2004, every time accompanied by statements that indicated where the Fed would go next. This policy framework kept inflation in the US under check. India, in contrast, lacked a coherent monetary policy. Changes in the repo rate, the reverse repo rate and the cash reserve ratio have repeatedly surprised the market, and have failed to keep inflation under check. Instead of calibrated changes in interest rates, consumers are now faced with sudden increases sharper than expected.
Why has monetary policy in India been so different from that in more mature economies? The most important factor that has come in the way of smooth movement of interest rates has been currency policy. In trying to manipulate the rupee-dollar rate, the RBI has purchased dollars in the market. When the RBI buys dollars, it pays for them using freshly printed rupee notes. This leads to greater money supply, higher credit growth and inflation.
If RBI really wants to pare inflation, it requires to bring an effective monetary policy.CommentQuote0Flag