Events & Issues
New Delhi, 19 September 2011
RBI Rate Increase
EXPECT SLOWER GROWTH
By Dr PK Vasudeva
(Adviser, Inst of Dev Studies)
The
business environment continues to remain extremely challenging this financial
year as it did last year. Even as there were signs of global economic recovery
in 2010-11, a number of geo-political developments have raised new concerns.
The
debt crisis in Europe, the earthquake and resultant tsunami in Japan and political turbulence in the Middle
East and North America have led to
considerable volatility in prices of commodities and currency exchange rates.
Worse,
the recent developments relating to the American economy have also impacted
markets. Whereby, the effects of the global financial tremors are also being
felt by the Indian economy. Add to this, the rising inflation rates which is nearing
double digit, remain a major concern for economists.
Importantly,
the Reserve Bank of India (RBI) continues to increase the interest rates, which
have led to the cost of borrowings going up. Not only have investment decisions
been affected but also it has impacted the rate of growth in the country’s GDP.
Indeed, only on Friday last 16 September the RBI yet again raised the price of
money, the twelfth time in about a year.
In
its monetary review report the RBI stated, “The inflation remains high,
generalised much above the comfort zone of the RBI. In recent weeks, as a
result of global risk aversion, the rupee has depreciated which may have
adverse implications for inflation.” Undeniably, this is also one of the
reasons why the crude prices are going up which is resulting in the hike of
petrol price in India.
However,
inflation has not come down and prices are still rising by 9-10 per cent
annually. Even the UPA Government’s Chief Economic Advisor Kaushik Basu seems
to think that this is the rate the country will have to live with for a long
time.
On
the other hand, the Finance Minister Pranab Mukherjee believes that inflation
has peaked but it could just mean prices will not rise more than 10 per cent.
Whether the rate of increase will decline is not something even he is sure of.
Recently,
the Prime Minister Manmohan Singh and his advisers insisted that growth was
possible at over eight per cent but without inflation crossing the Lakshman Rekha of 5-6 per cent for which
some strong measures like tightening the belt and reducing of subsidies would
have to be taken.
However,
the RBI maintained that any growth above eight per cent was risky from the
inflationary point of view. Finally, some months ago the Government came around
and accepted this view and lowered its growth targets to a sub-eight level.
Against
this background it is a moot point whether the RBI should have raised interest rates
now. Clearly, the RBI Governor Subbarao had very limited options available. Thus
money will now become a bit more expensive. Wherein, the middle class which desires
to buy homes and small cars would have to dish out a heavy interest on the
loans. Hence, the mid-income people might have to wait till the situation
improves and inflationary trends ease out. Coupled with this, unless the flow
of black money is stopped there is no likelihood of controlling the inflation.
Pertinently,
as far as big corporates are concerned, the recent liberalisation in the rules
governing external commercial borrowings (ECB) opens up more opportunities for
them to raise cheaper funds overseas. Without a doubt, they have now been
allowed to borrow up to a billion dollars in the renminbi, the Chinese
currency, within the overall $30-billion annual ECB ceiling.
Further,
a quarter of their ECB proceeds can be used to re-finance costlier rupee loans.
Therefore, the latest move by the RBI to make Indian money costlier should not
be a major obstacle for investment by large firms. This is the good news. The
bad news is that lesser mortals will have to think twice now before borrowing.
To that extent, the demand for money might abate and have some impact on
inflation. But by how much and when, even the most sophisticated models cannot
predict.
Moreover,
given the strong imported component in the current inflation, it could be
argued that unless the demand in the BRIC countries (Brazil,
Russia, India, China
and South Africa)
shrink substantially to bring down global commodity prices, the tinkering by
the RBI with rates might not be of much use. Undoubtedly, this is beyond the
control of the RBI.
This
apart, a related issue is the difference in interest rate between India and
abroad — now about 7 per cent — which could lead to higher capital inflows. Therefore,
in the absence of guaranteed returns as in the late 1980s, the current elevated
exchange rate risks might act as a speed-breaker. But nonetheless, the RBI would
still have to keep a vigilant eye because it is not just speculative flows, but
even higher overseas borrowings by Indian firms that could make a difference to
the balance of payments.
In
the ultimate, this shows that the RBI has sent the right signal. Governor
Subbarao has maintained for quite some time that the Bank does not mind
sacrificing a bit of growth to bring down inflation. Given that it is the worst
enemy of price rise, which needs to be controlled at all costs. In addition, the
growth of money supply, non-food credit and the Gross Domestic Produce (GDP) needs
to be checked to control inflation. ---- INFA
(Copyright, India
News and Feature Alliance)
|