It’s like – if you are wounded, then tighten the noose slowly and gently, but surely. The noose should not further hurt your wound and yet provide you protection from the outer world.
Yes, that’s what RBI seems to be doing rather well – ensuring that a rate hike is trickled down into the system at a gradual pace to tighten a noose around increasing pricing pressures thriving in a typically buoyant economy.
The central bank raised its key short-term lending and borrowing rates by 0.25%, or 25 bps, with an eye on spiraling inflation as a major concern. The RBI has been on a rate hike spree during the fiscal for as many as 6 times since March 2010.
The RBI policy rates of repo and reverse repo stands at 6.5% and 5.5% respectively after marking a 25 bps hike with immediate effect. However, the apex banker has kept CRR – the amount of funds that banks have to keep with RBI – untouched at 6%, to ensure flow of adequate liquidity in the hands of banks.
In its mid-quarter review of Dec 2010, the RBI had clearly warned about the risks of rising inflationary pressures which seem to be materializing on the back of surge in metal prices, non-administered fuel, up-tick in aviation turbine fuel prices and transitory supply shocks in food articles.Image Source: The Hindu
In December, the headline inflation shot up to 8.4% on a year-on-year basis, driven primarily by food and fuel inflation, after temporarily moderating to 7.5% in November.
The WPI inflation had hit a peak of 11% in April last year.
Considering that the household expenses have remained elevated for long, the RBI has revised its baseline projection of WPI inflation for March 2011 upwards – to a more realistic 7% from 5.5% forecasted earlier. The central bank also raised concerns on the prospects of high food prices spilling over to the general inflation.
Economy and Growth
Most of the times, a central banker has to deal with tough decision to choose between growth and price stability. And an even tougher job is to adopt a stance that needs a balanced approach between growth-inflation dynamics. Therefore, a rate hike was unavoidable albeit at a slower pace with a sequential approach.
In a pleasant note, the RBI has retained its growth forecast for 2010-11 at 8.5% with upward bias; and further said that growth has moved close to its pre-crisis levels as reflected in the 8.9% GDP growth in the H12010-11. However, RBI expects GDP growth to decline somewhat in FY12.
Fiscal and Current Deficit
The RBI sternly indicated that the country’s improved fiscal situation was simply a feel-good factor, driven by one-off revenues generated from spectrum auctions and government’s disinvestment proceeds, which may not be sustainable in future.
Further, if the government does not bring down its share of subsidies on rising oil and fertilizer prices or make budgetary provisions for such expenses, it will constrain its ability to reduce the fiscal deficit and undermine its fiscal credibility.
RBI has forecasted the current account deficit to be close to 3.5% of GDP for the year. Country’s trade deficit is going to widen in the current fiscal and is likely to be around $115-125 billion.
With all the hoopla surrounding rate hike, what concerns me is whether the surge in interest costs will succeed in curbing the inflationary impact most of which is driven by supply constraints? If not, it will simply make it unbearable for the aam-aadmi to pay off their rising EMIs for home and car loans.
Do you feel RBI is moving on the right path with its rate hike approach?