RBI - Raghuram Rajan's new joke !

The Finance Ministry recently announced that it will provide banks with additional liquidity so as to finance cheap loans for automobiles & consumer goods this festive season; to help the middle class population of our country. Though announced by the Fin-Min, but what is amusing and surprising is that this was done after taking a nod from the RBI governor. Ahem!

The RBI governor who in his previous review of the monetary policy said that it is imperative for the RBI to target and fight inflation first and then look for recovery and growth in the economy had hence increased repo rate by 25bps. This was seen as a move to reduce and contain inflation, which is still at a level more than the reserve banks comfort level. And then soon Fin-Min announces a release of liquidity into the system by providing cheap loans.

Even a naïve will know

what excess liquidity does to the inflation in the system. I really can’t come to terms with the RBI governor as to why such a step was taken. It remains to be discovered with time, whether or not such a decision was taken under the political pressure, sighting Raghuram Rajan’s close ties to the North Block.

The dilemma of RBI governor in increasing the cost of funds by increasing the repo rate and increasing liquidity in the system by reducing the MSF (Marginal Standing Facility) to 9.5%, at the same time is absolutely palpable. How it reflects into inflation and economic growth hitherto remains to be seen.  

On one side Rajan is tightening the liquidity by increase interest rates and on the other infusing liquidity into the system naming it as help to the middle class this festive season.

Instead of all the above, I would suggest the RBI Governor to reduce repo rates and selectively tighten credit costs to sectors where demand pressures persist. This will not only simulate growth prospects but also keep inflation under check.