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Credit Policy for 2008 - 09 : The Spectre of Inflation


The announcement of the monetary policy for 2008-09, by Governor Reserve Bank of India (RBI) on April 29, 2008, had attracted more than normal interest such events usually claim. There were at least three reasons for such extra-ordinary interest. First, the spectre of inflation loomed large on the horizon. Inflation, based on the wholesale price index (WPI), on a year-on-year basis, stood at 7.4 per cent at end-March 2008, as compared with 5.9 per cent a year ago. As on April 12, 2008 the headline inflation stood at 7.3 per cent as against 6.3 per cent a year ago. Was this a monetary phenomenon? Money supply had risen above indicative projections persistently through 2005-07 largely due to sizeable accretions to RBI’s foreign exchange assets and acceleration of credit and deposit growth, particularly the latter, in 2007-08. For instance, money supply (M3) rose by 20.7 per cent in 2007-08 close on the heels of an increase of 21.5 per cent in 2006-07. In fact the trend in inflation seems to have persisted in subsequent weeks, with WPI recording a rise of 7.5 per cent on April 19. This level of inflation, which is the highest during the last 42 months, is far above the tolerance limit of 5 per cent and hence reining in of inflation had acquired a sense of urgency. Second, the global environment for control of inflation has turned hostile. Prices of crude oil which have rebounded since July 2007, recorded a rise by 83 per cent upto April 25, 2008 from their level a year ago, with the price soaring to a record level of around US$120 per barrel. In the global foodgrains market, prices of major crops wheat, corn and soyabeans had risen by 56 per cent, 58 per cent and 86 per cent respectively, from a year ago, in response to surge in demand. The outlook for global growth has worsened. World gross domestic product (GDP) growth in real terms, on the basis of market exchange rates, is expected to decelerate from 3.7 per cent in 2007 to 2.6 per cent in 2008 and 2009. Third, Governor of RBI seemed to be in a mighty hurry to tackle inflation. Although the Policy Announcement was scheduled on the 29th April, Governor thought it appropriate to announce on April 17, the raising of the Cash Reserve Ratio (CRR) of banks by 50 basis points to 8 per cent. This was required to be implemented in two phases, to 7.75 per cent from April 26, and to 8 per cent from May 10, 2008. With this increase in CRR, an amount of Rs. 18,500 crore of resources of banks would be impounded.

Did this pre-empting in a way, of the policy pronouncement of April 29, symbolise the pressing of the panic button by Governor, RBI? This gave rise to apprehensions, on the part of the private sector, that the monetary policy package would be tough, probably with raising of interest rates and tightening of credit. Would the April 29 measures reflect a trade-off between growth and inflation?

Measures: April 29

Against this build up of inflation spectre, the announcement of monetary measures’ on April 29 came as an anti-climax. The Bank Rate was kept unchanged at 6 per cent, so also the repo and the reverse repo rates at 7.75 per cent and 6 per cent respectively.

The only change announced was further raising of CRR by 25 basis points to 8.25 per cent with effect from May 24, 2008. This would mean a further impounding of banks’ resources by another Rs. 9000 crore or so.

This was a master stroke by Governor who proved that the apprehensions of the private sector that the interest rate structure would be adjusted upwards were misplaced. Subsequently many banks have clarified that lending rates would not be raised. This also demonstrated that RBI was as much concerned with growth as with control of inflation.

The Rationale

Governor’s Policy statement provides analytical insights into the phenomenon: the battle against inflation is far from over; but the manner in which it needs to be tackled would be different somewhat because the current inflation is not a purely monetary phenomenon. Governor’s statement also makes it clear that in the measures taken there is no trade-off between growth and inflation. In fact RBI places GDP growth in 2008-09 in real terms, in the range of 8 to 8.5 per cent. Although there is some deceleration in growth from 8.7 per cent in 2007-08 to 8 per cent, what is important is that the Indian economy continues to be in the high growth league.

The stance of monetary policy for 2008-09 has been spelt out as follows:”…. the policy endeavour would be to bring down inflation from the current high level of above 7.0 per cent to around 5.5 per cent in 2008-09 with a preference for bringing it close to 5.0 per cent as soon as possible, recognising the evolving complexities in globally transmitted inflation. The resolve, going forward, would continue to be to condition policy and perceptions for inflation in the range of 4.0 – 4.5 per cent so that an inflation rate of around 3.0 per cent becomes a medium-term objective consistent with India’s broader integration into the global economy and with the goal of maintaining self-accelerating growth over the medium-term”. (para 87, page 37).

To the extent that monetary factors are responsible for inflation, RBI seeks to moderate money supply. “In view of the resulting monetary overhang, it is necessary to moderate plan monetary expansion and for a rate of money supply in the range of 16.5 – 17.0 per cent in 2008-09 in consonance with the outlook on growth and inflation so as to ensure macroeconomic and financial stability in the period ahead”. (para 88 on page 37).

Supply-side Pressures

The most important analytical insight provided by Governor’s statement is that the pick-up in inflation during the fourth quarter of 2007-08 has mainly emanated from supply-side pressures: these include the one-off increase in domestic petrol and diesel prices to partially offset the global crude oil price rise over the year; rising prices of wheat and oilseeds; and the adjustment in steel prices in March 2008 due to surge in international prices. Several administrative measures have been taken to moderate the price rise: these include reducing import duty on rice and edible oils, ban on exports of non-basmati rice and pulses, increase in the minimum export price relating to basmati rice. Stock limits on selected agricultural commodities have been imposed. The April 29 monetary policy package also includes a directive that banks should ensure that bank finance is not used for hoarding of commodities (page 64).

The market responded positively to the cumulative impact of credit policy of RBI and the administrative measures taken by Government. The Sensex rose by 363 points on April 29.

In fact in India the crux of containing inflation lies in controlling prices of essential commodities or primary articles which have a weightage of 22 per cent in WPI basket. And in this area the prospects are quite bright. Total foodgrains production is expected to reach in 2007-08 to an all-time high of 227.3 million tonnes from 217.3 million tonnes in 2006-07.

The impact of this bumper harvest is reflected in level of current procurement of wheat and rice. Food Corporation of India (FCI) has already exceeded its procurement target of 150 lakh tonnes of wheat. By the end of the season its total procurement may reach around 170 lakh tonnes. Similarly, FCI is also confident of exceeding its target of 27 million tonnes of rice by the end of the rice marketing season which ends in October. This more than comfortable supply position should have a salutary impact on prices of not only these two major cereals but on food articles in general.

This optimistic outlook is further reinforced by the forecasts of monsoons which predict a near-normal rainfall at 99 per cent of the long period average for the country as a whole in the 2008 South-West monsoon season. Irrespective of what happens to global availability of rice and wheat and to their global prices, India can enjoy the luxury of isolating itself from these forces.

Thus in the India – specific situation of today, the foodgrains position and outlook would substantially reduce the burden of monetary policy in its efforts to contain inflation.

Other Developments

The Policy Statement also provides information on a number of developments in the financial sector. Three of them may be briefly mentioned here: Financial Inclusion, Micro-finance and Reports of the Financial Stability Forum.

Financial Inclusion

It may be recalled that 277 districts had been identified for 100 per cent financial inclusion. Out of these, the target has been achieved in 134 districts in 18 states and 5 Union Territories. Interestingly, all districts of Haryana, Himachal Pradesh, Karnataka, Kerala, Uttarkhand, Puducherry, Daman and Diu, Dadra and Nagar Haveli and Lakshadweep have achieved 100 per cent inclusion.


As is well-known, the SHG-Bank Linkage Programme has emerged as the major Micro-finance programme in the country and commercial banks, RRBs and cooperative banks are involved in he exercise. There were in all 28.94 lakh SHGs with an outstanding bank loans of Rs. 12366 crore. Commercial banks accounted for 70 per cent of outstanding loans, while RRBs and Cooperative banks accounted for 23 per cent and 7 per cent respectively.

Report of the Financial Stability Forum (FSF)

In the wake of the recent turmoil in the global financial markets, the FSF brought out, in April 2008, a Report identifying the causes and weaknesses in the international financial markets. The Reports embodies proposals for strengthening prudential oversight of capital, liquidity and risk management, enhancing transparency and valuation, changing the role of credit ratings etc. RBI has already put in place regulatory guidelines covering many of these aspects. The states of RBI’s response to these proposals is indicated in the Policy Statement.

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