RBI's rate hikes may not tame inflation: Economists

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Mithun Dasgupta | 27 Jan, 2011
With supply side constraints the main reason for the spike in the prices of essential items, the latest hikes in short-term lending and borrowing rates by the Reserve Bank of India (RBI) may not help in reining in the inflation and the need of the hour is to increase food production, economists maintain.

"The recent hike in repurchase rate and reverse repurchase rate will not be effective in taming skyrocketing prices of essential commodities," eminent economist Abhirup Sarkar said.

"The high inflation is due to the double-digit food inflation and high prices of petro-products," said Sarkar, a professor at the Indian Statistical Institute.

"Increase in food production and decrease in amount of money supply are essential to control soaring food prices," Sarkar said, adding: "Repo rate and reverse repo rate are not the tools to curb high inflation rate."

The RBI Tuesday raised repo rate at which the central bank lends to commercial banks, and reverse repo rate, the interest it pays banks for deposits, by 25 basis points.

But economists said the apex bank could have increased these policy rates by 50 basis points, instead of 25 basis points.

"Currently, the real interest rate that factosrs inflation is negative. That means the nominal interest rate is lower than inflation rate," Sarkar said. "It's really harming the people who deposit their money in banks for earning interest amount."

Sarkar said doubling the short-term interest rates would not have impacted the country's growth momentum. RBI governor Duvvuri Subbarao has kept the economic growth forecast for the current fiscal at 8.5 percent with an upward bias.

Dipankar Dasgupta, a former professor of economics at the Indian Statistical Institute, also said the hike in policy rates would be unable to reduce high inflation. "This is the seventh rate hike since last January. But we saw in the past that the hikes had no bearing on inflation," he added.

But he said the policy rate hikes will hamper the growth of the manufacturing sector.

"The hikes in rates will increase investment cost by raising interest rates at which banks provide loan to companies. Thus, manufacturing sector growth will be less and that will lead to less employment in the sector," Dasgupta said.

It will, however, not have any bad impact on the growth as the present momentum in the country's national income is being driven by the booming service sector. Dasgupta also emphasised on increasing food grain production to reduce the high inflation rate.

"I think the latest policy rates hikes will not have any impact on the soaring prices of essentials, as the prevailing high inflation is due to high speculative demand in the money market," said Bipul Malakar, professor of economics at Jadavpur University.

Reducing the speculative demand in money market and increasing the growth rate in the material sector would be the key to check high inflation, he said.