RBI rates: Pre-emptive hike in store?

RBI rates: Pre-emptive hike in store?
The Hindu Business Line, 7th August 2009, Page 6

S. Balakrishnan

No one can say we weren’t told.

Both in its Quarterly Monetary Policy Review and the RBI Governor’s J. R. D. Tata memorial lecture last week, the message is clear. Raising repo rates from the current levels is inevitable; the only question is, when. In fact, even earlier, well before the Policy Review, the central bank’s chief expressed discomfort at the high level of liquidity in the banking system and fiscal deficit.

The RBI is ‘rearing to go’ and clearly has its foot on the interest rate pedal.

Actual Inflation

The toughening posture is not difficult to understand. The Governor has taken great pains to explain that the current sub-zero inflation data are purely statistical.

The weekly report of the Wholesale Price Index (WPI) actually measures the annual inflation, point-to-point, between this week, this year, and this week-last-year. So, though prices are declining on a year-to-year basis, they are not on a current week-to-week basis.

Monsoon setback

The RBI actually has its hands full. Strengthening the case for increasing rates is healthy personal consumption and Government spending. The Quarterly Review did a great service in bringing out with clarity the economy-propping contribution of public expenditure – it is true not always for the best purposes and causes – but for which a recession was certain.

But the failure of the monsoon is a setback for India’s still very large rural economy and will hit agricultural production and rural incomes while creating food price pressures. The full effects are not yet visible.

Exports

Exports are another shocker, dropping close to 30 per cent in the last year. It is obvious, the reason for our comfortable reserves is foreign portfolio investment and remittances.

On the other hand, the fiscal stimulus, coupled with soft liquidity and interest rates, has boosted stock markets. There are reports – though still only a smattering – fall of realty prices stopping.

The logic may also be that the economic environment is not propitious for a prolonged period of monetary sustenance, if it isn’t going to improve the investment climate anyway.

Of course, merely pushing up repo rates will not achieve the tightening objective as money rates tend to be influenced mainly by system liquidity, which, at over Rs 100,000 crore, is ample. The RBI will take a bite out of this.

The unfortunate aspect of the overall economic situation is the poor rains, which has weakened domestic growth impulses.

It is this which will make the RBI think if its policy posture at this moment is not overly risky.