What the RBI does in these circumstances should be dictated by the likelihood of its measures having a positive impact on inflation, even if there is some collateral damage on the growth rate. The worst possible outcome would be if, consequent upon a repo rate hike, the growth rate were to drop even more than it is currently expected to do, without any appreciable impact on inflation.

Such is the risk of monetary responses to supply-side or cost-push inflation, which is essentially what the economy is going through now. The impact of various actions that the government has taken over the past few weeks, involving lower tariff rates and new export restrictions, should become visible over the coming weeks.

In this context, it should be a matter of some relief that the inflationary pressure that had resulted from surges in the prices of food items (particularly pulses and edible oils) and metals (particularly iron and steel), has already eased. In part, this is due to international price drops, and in part because of the actions taken by the government. Contributing to the slightly more relaxed outlook is a third factor: the advance forecasts for the south-west monsoons by both domestic and international agencies, which predict normal rainfall.

In last Friday's weekly inflation announcement, the prices of both pulses and edible oils were actually down over the previous week. The momentum is now largely confined to metals, with the price of iron ore having increased by 6 per cent over the previous week. The prices of steel-using products also reflect the impact of the sustained increase in steel prices.

Of course, it is also true that the international price of crude oil has risen way above the $100/barrel mark, taking the benchmark price of the Indian import basket along with it. The already huge gap between the cost of crude and domestic retail prices for petroleum products has widened further, intensifying the conflict between inflation management and fiscal discipline on account of the oil bonds, with which the government is partially compensating the hapless oil-marketing companies.

Even with this threat lurking in the background, however, the prudent course of action for the RBI would be to hold the repo rate where it is. The CRR hike satisfied the need to be seen to be acting. A repo rate hike may hurt growth far more than it will help deal with an inflation rate that is already dropping.

 The Monetary and Credit Policy 2007-2008