Given the softening of crude prices and mild softening of inflation perhaps the hike could have waited, but it does give the RBI room to cut rates later.
Sonal Varma,
India Economist,
Lehman Brothers
While the economy is entering a down-swing, it is not clear that it is slowing fast enough to bring inflation down without a forceful policy response
The aggressive policy tightening by the RBI is a prudent response to the dilemma between surging inflation and moderating growth. First, the initial burst in inflation was a supply-side one, led by rising global commodity prices. However, with rising cost pressures and still-strong domestic demand, firms have increased output prices for most manufactured products. This pass-through is still partial, however, suggesting the risk of another round of output prices increases unless demand is tempered. For instance, excluding food and energy, core wholesale price inflation has risen to 12.0 per cent year-on-year in mid-July from 4.3 per cent in January 2008. Such broad-based inflation increases, at the aggregate level, the risk of un-anchoring inflation expectations unless there is an aggressive policy response.
Second, while the economy is entering a downswing, it is not clear that it is slowing fast enough to bring inflation down naturally without a forceful policy response. The momentum in the investment-led economy is strong and services sector growth, while moderating, remains robust. Most monetary and credit growth indicators also indicate moderation, not a collapse, in the economic growth rate. The slowdown is mainly confined to the industrial sector and this appears to be a result of not just slackening demand, but also supply-side capacity constraints in the infrastructure sectors.
Third, aggressive monetary policy tightening is needed to counter lax fiscal policy, including rising subsidies, the farm loan waiver and the salary hikes under the Sixth Pay Commission. And with lack of manoeuvrability in using fiscal policy and rupee appreciation to combat inflation — due to surging fiscal and current account deficits — monetary policy has become the first line of defence.
And fourth, monetary policy works with long lags. By front-loading the rate hikes, the RBI has not only been pre-emptive on inflation but has also given itself more flexibility to reduce rates in the future, if growth weakens significantly.
One of the key lessons policymakers learnt from the 1970s oil price shock was that high supply-side inflation should not be tolerated for too long. The RBI’s aggressive response will likely hurt short-term economic growth with both investment and consumption demand likely to moderate, but it is warranted since the potential costs of not responding would likely be more dire — high, sustained inflation can do serious damage to an economy’s long-run growth potential as it discourages savings, heightens investment uncertainty, and erodes export competitiveness.
To its credit, the RBI did moderate overheating symptoms in the past and only time will tell whether it steers the economy smoothly over the current inflationary shock. Until then, maintaining this inflation-growth balance will require all the artillery the RBI possesses, as the growth challenge has just begun.
Bharat Banka,
CEO - Private Equity Business Aditya Birla Group
When both the lagged effect of monetary policy and global cues of sanity are viewed together, further tightening could have waited for a while
If there is one unenviable job today, it is that of coming up with a monetary policy that can please every one. The RBI’s concerns on inflation and the consequent impact on the ordinary citizen can clearly be seen in policy announcements. It also appears the RBI did not want to take a chance on demand contracting on its own despite early indications of the IIP slowdown and subdued demand in most areas. The policy document seems to give clear indications of which side the RBI will lean if a choice has to be made between somewhat more moderate industrial growth and probabilistic moderate inflation.
There is a section which believes that given the aggressive monetary moves of the past few months, it might have been more prudent to wait and assess the real impact of the measures already taken before tightening any further. It also becomes significant to understand that this time around, inflation is more a global phenomenon than a domestic demand- or liquidity-driven one, and is contingent on what happens to global commodity prices including possibly a further meltdown of financials in western economies.
Even before the policy was announced, there were mild signs of commodity and oil prices sobering down and a flattening inflation curve. When both the lagged effect of monetary policy and global cues of sanity are viewed together, further tightening could have waited for a while. While the RBI wants credit to grow at a slower pace, the system might still have enough liquidity and credit may still be available. In which case, what will matter is the cost of credit delivery and the extent to which costs will be passed on to the borrowers. Convention wisdom suggests that delivery of credit might still not get impacted significantly but the same can not be said about cost of credit which appears to be headed to become expensive — lenders have already absorbed part of previous hikes, but this time around it could be different. The impact on business growth and profitability and, in turn, market capitalisation of rate-sensitive sectors will be unavoidable.
However, when the current situation is compared with the 1990s, the size of the Indian economy has grown manifold, industries have become more mature and globally-oriented as compared to inward-looking in the past and corporate balance sheets are sounder and more resilient. This should make it possible to have confidence that growth will not suffer too much despite the monetary tightening. But, by the same token, a wait-and-watch policy for some more time might not have been a bad idea. Eventually though, it seems the markets might be getting closer to a situation where the next set of monetary measures could be more spaced out with lower frequency and intensity.
The views expressed are personal
