Early to rise

The majority view (which means not universally held) was that the Reserve Bank of India (RBI) would step on the brakes once more in its quarterly monetary policy announcement, due at the end of April. In the event, the double-barrelled approach that it has adopted in recent months, raising both the repo rate (which is the rate of interest at which it makes money available) and the cash reserve ratio (CRR, by which money is sucked out of the system), has been exercised a month early, leaving people surprised about the timing and also the sharpness of the move. What perhaps tipped the scales in favour of immediate action were the quarterly balance of payments numbers, released last Friday. Even though they are a couple of quarters out of date, they indicate a strong trend towards a narrowing of the current account deficit, driven by both moderating oil prices and booming service exports and remittances. Meanwhile, capital inflows, including foreign direct investment, portfolio investment and commercial borrowing by Indian firms, continue unabated. These patterns point to a significant increase in domestic liquidity and the fuelling of continued credit growth, which in turn dilutes the impact of monetary measures designed to curtail both. This is the primary reason why the RBI abandoned its single-instrument approach and went back to CRR hikes last December. Clearly, as long as the balance of payments tilts towards surpluses, the RBI will feel inclined to offset these with more stringent constraints on liquidity.

That said, there are obviously other considerations that led to the earlier than scheduled repo and CRR hikes. One, the inflation rate has held stubbornly steady at a shade under 6.5 per cent for a number of weeks. Even if one were to discount this number for the significant impact of food prices, the fact is that the prices of manufactured goods have been rising at over 6 per cent, which is above the RBI's comfort zone and reinforces the perception that the economy is over-heating. Second, whatever evidence there is about the performance of the economy during the current quarter does not suggest any significant flagging of the growth momentum. The industrial production numbers for January showed double-digit growth in manufacturing. Corporate results for the quarter have not yet been announced, but the indications so far are that the robustness of the last few quarters will be sustained. These mean persistent demand-driven pressure on prices.

These factors would have persuaded the RBI that another round of hikes was inevitable. Once having reached that conclusion, the bosses on Mint Road would have decided that there was no merit in waiting for April before making their next move""even though the unexpected announcement could potentially unnerve markets. It is of course possible that, when the markets open later today after a week-end when people would have mulled over things, the conclusion may well be that the advancing of the schedule isn't such a big deal. But it is also true that recent days have been turbulent in the overnight call money market, pointing to tightening liquidity. With the RBI sucking out still more money from the system, and signalling a hike in interest rates, it is clear that the central bank is now determined to tame inflation and to do so by curbing demand""which means a slower GDP growth rate. Expect an increase in all interest rates, whether for housing loans or for lending to companies. The inevitable questions now are whether the RBI is done with jacking up rates, and how much momentum the economy will lose as a consequence of the tightening.