Reserve Bank of India's Governor Duvvuri Subbarao backs his conviction with a determination unmatched among economic policy makers in India. For the second policy statement in a row, he ignored advice, most of it unsolicited, and raised interest rates for the twelfth time in 18 months. The increase was backed by a tone so clearcut in its focus on inflation that some were left with the feeling that the cycle of rising rates had not yet ended. For instance, Samiran Chakraborty, Regional Head of Research, India, Standard Chartered Bank, expects another 25-basis point increase next time.
The September 16 policy statement from RBI, the only institution in India with a mandate to stamp out inflation, while raising the repo rate, the rate at which banks borrow from RBI, by 25 basis points to 8.25 per cent, did not indulge in any talk of trying to balance growth and inflation. It simply said the expected outcome of the rate hike would be to "reinforce the impact of past policy actions to contain inflation and anchor inflationary expectations".
Hike will not tame inflation: India Inc
The industry lobbies reacted predictably, as the rate hikes have begun to bite. But this time the lobbies found a vocal ally in Kaushik Basu, Chief Economic Adviser in the Ministry of Finance, who said he did not think nudging up interest rates was the right solution any longer. RBI was left with no choice but to beat a lonely and unpopular path because the fiscal action needed to complement monetary action will not happen. If the fiscal deficit, budgeted at 4.6 per cent of gross domestic product in 2011/12, is pulled back, RBI can also re-visit its policy stance.
| COURSE CORRECTION|
If I had a vote, I would cast it for a pause on the rate hikes. We cannot compromise high growth in the long term: Kaushik Basu
Government has not tackled supply-side issues. So, demand continues to outstrip supply. So, high inflation is persisting: Rajiv Kumar
We are on a trend of high inflation and falling growth. We need major policy intervention: Chandrajit Banerjee
Instead, the growing danger is that the deficit may be more than what the budget projected. "Short-term measures are very difficult on the fiscal side," says D.K. Srivastava, Director of the Madras School of Economics, who was a member of the Twelfth Finance Commission. Enhancing the supply of food and manufactured goods in the economy is the only long-term tool to rein in inflation. "We can't go on like this. We need major policy intervention from the government to go beyond monetary policy," says Chandrajit Banerjee, Director General at business lobby, Confederation of Indian Industry.
In the war on inflation, there are limits to what RBI can achieve without government support. And government support is not exactly forthcoming at this time. Reacting to the latest rate increase, Finance Minister Pranab Mukherjee, after the usual expression of hope, rounded off his statement with: "There are also signs of growth being affected by monetary tightening in the recent data on the real economy."
That data shows slower growth - the International Monetary Fund puts it at 7.50 to 7.75 per cent for this financial year - without any slowing of inflation, which has grown faster than nine per cent over the past year. Anything above 4.5 per cent makes RBI squirm. "Demand continues to outstrip supply. So, high inflation persists. The monetary policy only affects demand, it cannot push the supply side," says Rajiv Kumar, Secretary General, Federation of Indian Chambers of Commerce and Industry, another business lobby.
The rate of inflation in an economy remains high as long as demand outstrips supply. To ease the supply-side constraints, the government has in the past year taken only mini steps. It banned export of onions, but allowed it a few days ago
, and eased import of edible oils. RBI has consistently said that much of the food inflation is coming from a shift in demand patterns owing to better spending ability of consumers. For instance, an increased intake of proteins has kept the inflation in milk and meat high for more than a year. Tackling such shifts in demand requires higher supplies.
The fallout is that inflation, as RBI has warned in successive policy statements, has spread to nonfood segments. This happens whenever food inflation is persistently high, as producers are forced to raise wages. Not surprisingly, non-food manufactured products inflation in August rose from 7.5 per cent to 7.7 per cent. "A further pullback in aggregate demand needs action on the fiscal front," says Basu.
Basu chooses stronger words. "Growth is being affected by what RBI is doing to control inflation. It is okay to make a short-term compromise to control inflation, but in the long run we want growth to remain high and buoyant," he says, adding that if he had a vote on rate hikes, he would hit the pause button. Basu does have a vote. He chairs the Inter Ministerial Group on ways to curb inflation, which periodically makes recommendations to the government.