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Will Subbarao bite the bullet?

Last Updated: Sunday, July 25, 2010 - 10:25

Stanly Johny

The Reserve Bank of India (RBI) is all set to increase its key lending and borrowing rates when it reviews the quarterly monetary policy on July 27. Given the RBI’s commitment to fighting inflation and other money-linked threats to the economy, industry captains and economists expect the apex bank to raise the repo and reverse repo rates by at least 25 basis points. If so, it will be the fourth time the central bank raising interest rates this year.

At present, the repo rate, RBI’s main lending rate, stands at 5.50 percent, while the reverse-repo rate, or borrowing rate, is at 4 percent. "The RBI is set to continue its calibrated exit from its accommodative monetary policy until the momentum in non-food manufacturing inflation slows," Barclays Capital analysts said in a note to investors.
RBI Chairman D Subbarao hardly springs surprises. His policy actions have always been on expected lines. He avoids radical policy decisions as the economy is still on recovery path, takes advices from the government and always prefers to go slow on the economically sensitive policies. Will that “go-slow” attitude help the economy in the long run? Or, is it time for the RBI to get a bit more aggressive?

A plain analysis of facts will tell us that the previous three rate hikes have not helped the economy in a great deal to fight inflation. Though food inflation is easing a bit, headline inflation is ruling in double digits, and is expected to go up further.

Wholesale prices were up 10.55 percent in June from a year earlier, accelerating from May`s 10.16 percent. Earlier data have also been revised sharply higher with April inflation raised to 11.23 percent from 9.59 percent. Reserve money has also been rising rapidly in recent months. A pickup in money supply growth, will serve as another important signal of inflationary pressures ahead.

Not so rosy future

The future is also not so rosy. Monsoon rains, which the government is banking on to cool food prices with a bumper crop, have instead been running 13.5 percent below the long-term average this season. High demand for food and low output will skyrocket prices again. The inefficient public distribution system of the country can make things worse.

Also, the government’s recent decision to deregulate petrol prices from administrative control and hike the prices of other fuels will have cascading impact on inflation. Both the RBI and the government know that these factors would reflect in the WPI inflation for July.

Another major factor the RBI has to keep in mind while reviewing the quarterly policy is the widening current account deficit. With India expected to grow more than 8 percent this year and next, imports are expected to pick up. However, India’s exports sector is yet to return to the pre-crisis growth, thanks to the vulnerabilities of the advanced economies. As export growth is weak, rising imports threaten to push up the trade deficit up substantially, in turn widening the current account deficit, which reached $13 billion in the January-March quarter, its biggest since 1981. A more decisive monetary tightening to curb domestic demand would help keep India`s external imbalances in check.

The growing imbalances between credit and deposit growth should also alert the central bank. Bank credit is growing at an annual pace of around 22 percent while deposits grow at a 15 percent clip. So the credit-deposit ratio has widened to 73.44 percent in July from around 70 percent at the start of this year, climbing above the monthly average of the past five years of 69 percent. If the country wants more money in deposits, the interest rates have to go up.

Many believe another token rise of interest rates would not help the RBI achieve its key goals – fighting inflation and promoting long term growth. The government is giving mixed signals. When Finance Secretary Ashok Chawla advised the central bank to continue with its “gradualistic approach”, Prime Minister’s Economic Advisory Council Chairman C Rangarajan said it’s time for the bank to be more aggressive. So the ball is in Subbarao’s court, waiting for the kick-off.

The macro economy is doing far better than many expected last year. According to PMEAC, India would grow by 8.5 percent in the current fiscal. The industrial production rose in double digits for the eighth straight month in May. The country’s equities markets are trading at their two-year highs and the financial industry as a whole is also on a strong pitch. The RBI would not find a better time to take difficult policy decisions. Given the challenges ahead, Subbarao should give up his gradualistic approach and go for aggressive tightening. Though it might affect the retail borrowers and the industry in the short run, the economy as a whole will only benefit from such an action. Will Subbarao bite the bullet?

First Published: Sunday, July 25, 2010 - 10:25

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