The battle between doves and hawks is likely to end in favour of the former. The chances are that Reserve Bank of India (RBI) Governor Duvvuri Subbarao will opt for a 25 basis points hike in the repo rate, the rate at which the central bank lends short-term money to banks (100 basis points make 1 percent). The policy is due on Tuesday, 26 July. The pressures to keep the rate hike to the minimum (i.e. 25 basis points) currently outweigh the logic demanding a stronger monetary policy response. The logic in favour of either a 50 basis points hike on Tuesday, or at least a continued raising of interest rates all the way to March 2012, stems from still untamed inflation. The rise in the Wholesale Prices Index (WPI) will probably cross 10 percent in June or July. This is why non-sarkari economists are calling for a larger-than-expected rate hike. According to S S Tarapore, a former RBI Deputy Governor and inflation hawk, the “official price indices understate the true level of inflation, which, at the present time in India could be as high as 15 percent…”. This means the RBI “must twist a few limbs and break a few bonesbefore the genie of inflation gets back under the lid”. In Tarapore’s reckoning, “breaking a few bones” includes hitting the economy on the head with a 50 basis points hike in the repo rate, and an increase in banks’ cash reserve ratio (CRR) by 25 basis points, which will really crimp money supply. It’s probably not on. Another hawk is A Seshan, an economic consultant. Writing in Business Line, he says the real problem is growing acceptance of high inflation as a fact of life – which will make things worse. Despite official assumptions that inflation will fall after this crop or that season, prices have stayed stubbornly high for more than two years now. Since high inflationary expectations are now embedded in everyone’s thinking, what the system needs is a shock, says Seshan. And this shock can only be delivered by a hawkish interest rate stance. For Leif Eskesen, chief economist for India and Asean at HSBC Bank, money is still too loose. He says: “Monetary policy settings in India are still accommodative. Despite RBI raising rates, the real rates are still negative.” What he means is that banks currently offer you 9-9.25 percent interest on deposits when WPI inflation is even higher. You are thus earning negative interest in real terms. Till real rates turn positive, the incentive to save and bring down consumption demand will always be missing. Eskesen would thus be happy with a 50 basis points hike. Stephen Roach, non-executive Chairman of Morgan Stanley Asia, told The Economic Times that “The RBI has been self-restrained in raising real interest rates to reduce inflation…Right now there is probably a need for 50-100 basis points of monetary tightening over the next six-nine months.” But the views of hawkish economists are likely to fall on deaf years because of the circumstances in which the current credit policy is being crafted. First, GDP growth in slowing, and so is industry. The Index of Industrial Production grew at 5.6 percent in May, suggesting that the economy is losing steam. Politically, therefore, the pressure will be to keep rate hikes down, or even go for a pause after the next hike. Without growth, the tax resources needed for bankrolling the government’s expansive Food Security Bill will simply disappear. Second, industry is screaming louder with every passing day. A few days ago, Ratan Tata, while acknowledging inflation as an enemy, fretted that we may be going too far down the road to prevent it. “What should be of concern to all is the creation of a situation where the pendulum swings too far in the opposite direction, causing another global slowdown…”. Tata says that both China and India were headed in this direction. “The resulting high interest rates, tighter credit regimes and higher fuel costs will dampen consumer demand for a range of consumer products, including automobiles,” Business Standard quoted him as saying. Third, Subbarao is waiting for an extension of his tenure at the RBI. This is probably the last policy he will preside over till we know whether the government is going to give him shot at the job or not for a further two years. It makes sense for Subbarao to play it safe when his bosses are mulling over his extension. Net-net: Subbarao will probably opt for the politically acceptable 25 basis points hike in repo rates. To compensate for doveish action, he will spice it up with hawkish comments to assure the market that he has not thrown in the towel on inflation.
Firstpost
