Wildly swinging global markets, increasing nervousness about the global economic outlook and a plunge in commodity prices in recent days had led some economists to believe that the Reserve Bank of India (RBI) could hold off on raising interest rates any further. But those hopes may have been dashed after the latest set of food inflation data was released on Thursday: food inflation accelerated to 9.9 percent – the highest in three months – from 8.04 percent the previous week. In addition, State Bank of India chairman Pratip Chaudhuri told Business Standard newspaper that he expects the central bank to continue raising policy rates until inflation slides to 7 percent. SBI is frequently considered as a proxy of the RBI by market experts. There is little doubt the central bank is being pulled in opposite directions right now: on the one hand, inflation refuses to decline, which is forcing the bank to keep interest rates high; while on the other hand, the economy is obviously slowing down, and may not be able to cope with high rates for much longer.
So what will the RBI choose to target? Growth or inflation? According to a Mint report, the RBI’s focus is still likely to remain on controlling inflation. Wholesale inflation was 9.44 percent in June; it is not expected to slow before October. In its quarterly review of monetary policy, the RBI, in fact, raised its inflation estimates, saying that it expected to peak at 9.5 percent before slowing to around 7 percent by March next year. Yet, it cannot ignore that industrial activity has decelerated: in May, the Index of Industrial Production – a gauge of factory output – plunged to 5.9 percent from 20 percent in December last year. Bank credit also dipped to 18.5 percent (annual basis) in the fortnight ending July 29, from 19 percent the fortnight before. The RBI has raised its key policy rate 11 times since March 2010 in a bid to clamp down on rising fuel and food prices. Yet inflation remains dangerously close to double-digits. In recent days, the rout in global equities and commodity prices, especially crude oil prices, have raised expectations that the bank could decided to pause on its rate hikes. The belief is that lower commodity prices will help in doing what the RBI’s rate hikes could not do so far — lower inflation. It’s a logical argument, but the key question is how long commodity prices will stay subdued. At the moment, a global slowdown and a commitment by the US Federal Reserve to keep interest rates near-zero levels until mid-2013 seem to tilt the odds in favour of lower commodity prices – and lower overall prices. But not everybody agrees with that assessment. “For India, domestic dynamics have always been more important than the global situation,” Bank of Baroda chief economist Rupa Rege Nitsure told Mint.
“Inflation is not going to come down before October and RBI cannot afford to exercise a pause in rate hikes unless the global economy ‘goes for a toss’. The government may take advantage of a slowdown in crude prices and introduce reforms like freeing up of oil prices from subsidies. This will be easier done in a lower crude price scenario, but that does not correct inflation in its present form.” Indeed, if central bank governor D Subbarao decides to call time on hiking interest rates and inflation does not fall as expected, he is likely to come in for some more criticism for not doing enough to tame prices. An RBI survey released on Thursday said urban households expected inflationary pressures to continue until June 2013, and that food prices might not come down.
It’s too soon to say that D Subbarao will not hike interest rates in the near future. Right now, he – like everyone else – will just have to wait and watch to see how the global economy turns out before making a decision.
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