Finally, RBI may pause Interest Rate hikes…
RBI will conduct the mid-quarter review of the monetary policy tomorrow. There is a school of though that believes India’s apex banker will cut its key policy rates on Tuesday amid acute de-growth in the industrial output data by 5.1% in October 2011.
However, in my opinion, the RBI is more likely to take a pause in its policy review rather than resorting to a rate cut so soon after a series of rate hikes; in trying to balance inflation and growth.
This makes me wonder as to which of economic parameters and policy matters are getting at loggerheads with each other. Who is responsible for the stalled growth and sky-high inflation? Today, the biggest dilemma arising in my mind is whether policies aimed at reigning inflation are eating into the growth prospects of the economy?
Currently, the economic backdrop is surrounded by negative news flow from various quarters – be it sustained inflationary pressures, record depreciation in the rupee value, slump in industrial growth, rising trade deficit to $116.8 billion during this fiscal, political instability and ruptured mandate and brake on foreign inflows.
In a nutshell, it looks like a confusing mixture of pessimistic economic environment. But, if we look at the causes creating all this raucous, one can clearly determine the root cause of the core pain in the Indian economy. The three main reasons are:
- Serial hike in policy rates by the RBI
- Government inaction or stalled reforms
- Negative global news flow
For one, we have no control on the sovereign debt crisis originating in the US and the Europe; so we leave it as fate just like we have little control over natural calamities like floods, earthquakes, etc. Now coming to the remaining two aspects, wherein a series of RBI rate hikes have seemingly done more damage to the economy than the hibernating government action.
Let me explain how RBI rate hikes has affected each of the issues mentioned in the fourth paragraph:
1) Effect of RBI rate hikes on Inflation
When the new RBI governor Duvvuri Subbarao took over the office, his prime objective at that time was to curb the sky-high inflationary pressures. Moreover, he had ample room, then, to stretch on the monetary policy curve by way of administering rate hikes gradually.
But, somewhere down the line, he couldn’t draw the thin line of equilibrium that determines balance inflation and growth parameters in the economy. Allegedly, he over-reacted and went on increasing rates to stratospheric levels in the light of prevailing tough global environment.
The conventional wisdom that higher interest rates will reduce liquidity from the system and contain inflation, backfired in the form of reduced loan off-take and stifled industrial activity rendering demand-supply balance over the head. With reduced manufacturing output growth and constant demand, prices have gone up.
Time and again, RBI governor and Finance Ministry have stressed the significance of curbing inflation even at the cost of moderating growth expectations. However, it needs to be digested over here that despite high inflation, it is growth wheel of the economy that ensured India story stay put amidst the global downturn.
Now that their mantra is of curbing inflation is not yielding desired results even after a series of 13 rate hikes in 19 months, the central bank has gradually realized what every analyst was yelling for the last 6 months. The times have changed and now call for a prompt action from RBI to correct its past mistakes.
2) Effect of RBI rate hikes on Industrial Growth
With rising debt servicing costs domestically, the corporate world kicked-off with the damage control measures by borrowing funds from abroad. However, like a double-edged sword, this move to save on interest costs backfired with steeply depreciating rupee value to a dollar.
Now, with the rupee fall, corporate firms are neck deep in repayment of foreign bonds. They might reduce exposure to borrowed money for further expansion plans at the cost of growth. The weakened IIP figures are there for every one to see.
3) Effect of RBI rate hikes on FII pull-out
With decelerating industrial growth, FIIs have turned to other economies that are more profitable to invest, than wait for India’s crippled government to take reformist policy decisions. In such a scenario, it becomes imperative for the RBI to emanate positive signals that promote positive steps to prop up growth.
In this small world, promoting one’s unique proposition and reinstating its visibility amongst a group of emerging economies is of prime importance. Thus, without any positive news flow and prompt economic reforms, it is but obvious that the smart foreign money will flee to greener pastures elsewhere. On this front, not just RBI initiative, but also the government’s show of swiftness in policy formulations is equally responsible. So, the responsibility is 50-50 for both the RBI and the government to attract hot FII money.
4) Effect of RBI rate hikes on Rupee Fall
In the backdrop of foreign institutional outflows, and government’s inability to attract overseas investment, the RBI needs to take the initiative to provide for attractive avenues to foreign capital. Of course, RBI can not do much in this beyond its limits. It also needs to compliment govt actions. So responsibility is 25:75 for the RBI and govt to act on this regard.
Today, the value of rupee stooped to a low of 54.20 against an American dollar, leading to spasm in the back of importers in the country.
5) Effect of RBI rate hikes on Trade Imbalance
There is not much that the RBI can do with regard to rising trade deficit, except urging banks to prioritize loans to export oriented industry like IT/Software, tourism, etc. On the other hand, the government should give more incentives to export industries and discourage imports by way of duties where in sectors where India deals in abundance. The government could also extend additional tax rebates to export sectors, especially, in SMEs like hand made crafts, etc.
Our trade imbalance is more tilted in favor of import of crude oil and other fuels. Higher crude prices and depreciating rupee could only add to the woes of burgeoning trade deficit. Government should urgently try to clear regulatory hurdles in giving clearances and incentives to increase production of crude oil in the blocks of Rajasthan, as the desert state is the only known place in India which can fillip the nation’s dream of being a fuel-efficient economy, at least, partially.
So, can we expect a rate hike pause in the monetary policy tomorrow?