Manufactured products and primary agricultural commodities pushed up the wholesale price index (WPI) to a new two-year high of 6.73 per cent. This rate is well-above RBI’s projection of five to 5.5 per cent. Such relentless rise in inflation has forced the central bank to hike the cash reserve ratio (CRR) of banks and the repo rate, the key short-term rate.

The RBI raised the CRR by half a percentage point to 6 per cent. The increase reduces the amount of money banks can lend by Rs 14, 000 crore. The measure will come in two doses - 5.75 per cent from February 17 and then 6 per cent from March 3. On January 31, the RBI hiked the repo rate, by 0.25 per cent to 7.5 per cent. In the past one year, it had raised the repo rate four times.

Such moves have sent a clear signal to banks to restrict the flow of credit. For an average customer, availing a loan will be dearer now. At present, banks and financial institutions are charging about 9.25 per cent to10 per cent for floating rate loans and close to 11 per cent for home loans on fixed rate. The hike in repo rates will lead to further tightening of liquidity and the resultant hike in interest rates would mean increase in home loan rates by a further 25 to 50 basis points.

RBI is right in taking such measures. High rate of growth coupled with a high rate of inflation is not sustainable over a long time. But there’s reason to worry. Such measures might help cool the property prices in certain pockets, but will also affect corporate activity to a large extent. A high lending rate will drive away the genuine buyer from the market, affecting investment plans. In the long run this will have a multiplier effect on demand, which might slowdown the growth rate.

Similarly, it would impact the car sales. Such high rates of funds will lead to a fall in sales, which in turn will affect the top line of all car manufacturers.

The move is also likely to reduce the profitability of banks too. It has led to a fall in the American Depository Receipts of some top banks. A bank that is pushing lending rates up in line with the rising cost of funds might be able to protect its interest margins in the short term. However, it might end up with a rising pile of bad debt in the medium term. This will in turn hurt its interest earnings.

Apart from monetary measures, the government has to take several fiscal measures. It should look at the supply side. Basic commodities like wheat, vegetables, pulses and oil seeds are the large contributors to the recent rise in inflation. Government has to find ways to bring down the prices of such commodities. Analysts blame the government for ignoring supply side constraints.

To bring immediate relief to people, government should put a ban on export of certain essential commodities. And, if need be, it should also liberalise import of these commodities to bring down the escalating prices.

However, the decision to cut price of petrol by Rs 2 and diesel by Rs 1 is a prudent decision. This measure is expected to bring down the prices of food grains and vegetables carted across the country. RBI’s tightening monetary policy alone cannot bring down food prices.

So, in economies like India, a two-pronged strategy of fiscal and monetary measures will work better to contain inflation. Resorting to monetary measures will not bring a desirable result, particularly when the problem lies elsewhere. Following a policy of contraction in money supply - by making capital dearer - will dampen productive credit growth. In the absence of cheap credit the small and medium enterprises of the country will suffer.

But at the moment, there seems little doubt that controlling inflation has taken precedence over growth issues.