RBI gets real on growth PDF Print E-mail
Wednesday, 26 October 2011 00:00
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One more hike, but signals concern about GDP at last


RBI's latest policy has pleased the hawks (another rate hike) as well as the doves (no more hikes after this since growth will falter), but more than that, it has confounded. After focussing almost entirely on inflation all these months and talking of a sustained demand growth momentum which few others in the economy could see, RBI is now talking of growth risks and the need to contribute to stimulating investment activity. All of this with just one month’s WPI data! In September, RBI was talking of how “the inflation momentum, reflected in the de-seasonalised sequential monthly data, persists”. Yesterday, it said “reassuringly, momentum indicators, particularly the deseasonalised quarter-on-quarter headline and core inflation measures, indicate moderation”. Even more perplexing is RBI’s projection that, in another 5 weeks, inflation will begin to decline—isn't monetary policy supposed to be forward-looking? That is, if RBI knows inflation is declining—and the high base effect thanks to last year's elevated prices at this time will only accelerate this—why is it raising rates further, more so when it knows the impact of previous rate hikes is yet to be felt. Even more curious is the timing of the decision to free up savings interest rates—to the extent competition among banks will raise rates, this will quicken the transmission of the rate hike. This appears curious if RBI is trying to signal—“the likelihood of a rate hike in the December mid-quarter review is relatively low”—that it may even start lowering interest rates after a few months.

Possibly, RBI has finally woken up, or been made to wake up, to the reality that, along with overall government policy, its actions were bringing the economy to a grinding halt. Indeed, given how bigger industrial units have been able to make good the decline in bank credit by borrowing more overseas, the SME sector has taken the biggest hit. Also, with growth slowing, there is the danger of the other spiral getting stronger … as GDP slows, so do tax collections and the government begins to borrow more, the rupee weakens and India gets more prone to imported inflation—the RBI has said that the rupee depreciation has more than offset the impact of a fall in global crude prices.

What needs watching, RBI has stressed, is what the finance ministry does to keep inflation low. If the finance ministry continues to borrow more to fund unrestricted expenditure, it will be difficult to keep a lid on aggregate demand. Moreover, given how food inflation is so decisively driven by hikes in procurement prices, a lot depends on how populist the government wants to be. This is the fundamental dilemma of inflation-control—RBI cannot be hiking interest rates while the government keeps spending away and does little by way of policy actions to attract investment.



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