There have been suggestions that the Reserve Bank of India (RBI) should follow the examples of the central banks of Turkey (in January) and Brazil (in August) and reduce interest rates in an inflationary situation. Turkey’s high interest rates had led to the inflow of hot money with the Turkish lira appreciating and hurting exports. The lowering of the policy rate was aimed at reducing the flows to discourage arbitrage and carry trade. In order to pre-empt any increase in domestic demand for credit due to the lower interest rate the central bank raised the Reserve Requirement Ratio (RRR) steeply to 15 per cent in January and to 16 per cent in April. It does not pay interest on the reserves.
The central bank’s strategy was to lower policy interest rates coupled with higher and repeatedly raised reserve requirements, differentiated by deposit maturity, a wider interest rate corridor (between its overnight lending and borrowing rates) to discourage short-term foreign capital inflows and to slow domestic credit expansion. The consumer price index has recorded an increase in inflation rate from 4.9 per cent in January to 6.7 per cent in August.
On August 31, the Central Bank of Brazil cut its benchmark interest rate by half a percentage point to 12 per cent that is far higher than India’s. The increase in the primary fiscal surplus from 3.1 per cent to 3.4 per cent of GDP opened up space for the cut — a situation hardly comparable with India’s.
A Seshan, Mumbai
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