|Monday, 02 May 2011 00:00|
By now, it’s pretty much of a foregone conclusion that even if a hike in policy rates by RBI tomorrow won’t help curb inflation, it will certainly jeopardise India’s growth prospects. While the repo rates rose from 4.75% in March 2010 to 6.75% right now, and reverse repo from 3.25% to 5.75%, this hasn’t had anywhere near the desired effect on curtailing WPI inflation, which was just under 9% in March—it was nearly 13% for primary articles, a little over 6% for manufactured products and around 13% for fuel and power, the latter likely to rise further once fuel prices are raised after the West Bengal assembly elections are over. The impact on lowering GDP growth, however, appears a lot more certain, especially since growth has already been trending down. Growth in real gross fixed capital formation, Crisil estimates show, fell from 26% in the first quarter of 2010-11 to 6% in the third quarter on a year-on-year basis; once you do a seasonal adjustment on this, quarter-on-quarter growth fell to -5.3% in Q3. Much of this, in any case, can be seen from the falling order books of most capital goods manufacturers. If RBI raises policy rates, the banks will pass them on this time around—of the 75 bps hike in repo rates since December, commercial banks raised rates their base rates by 65 bps. Our Oped columnist Saugata Bhattacharya points out that even this underestimates the impact—see his chart on how the 200 bps hike in policy rates last year has resulted in a situation where the cost of short-term funds for banks, and companies, has gone up 400 bps. So, borrowing is getting costly, whether RBI hikes rates or not.
But the question is whether there is an alternative to hiking rates. Sure, we know GDP growth will get hit, but how else is inflation to be tackled? This is tricky, especially since part of the inflation, such as in commodities, is imported and can’t be easily tackled. A few points can, however, be made. JPMorgan chief economist Jahangir Aziz pointed out to FE, a few days ago, that no company had raised capacity in India since 2008. Clearly, this is a factor in manufacturers inflation rising. So, if the government were to make it easier to get land and various environment and forest clearances, capacity would go up significantly, and prices would get a breather—think of Posco and other big projects to know how serious the problem is. The short point is that the government has to aid RBI in its inflation-fight. Monetary policy can’t work in the presence of large fiscal deficits; similarly, if the investment environment is not improved, the economy will heat up faster.