Make it a non-event

The previous governor of the Reserve Bank of India (RBI), Bimal Jalan, once expressed his wish to make the half-yearly monetary and credit policy announcement a "non-event". His wish was fulfilled, in a sense, with a long sequence of announcements in which no interest rate changes were announced, spanning the last couple of years of his term and the first year of Y V Reddy's. The string was broken in October 2004, with a 25 basis point hike in the reverse repo rate. This was motivated by fears of inflationary forces strengthening under the combined influences of good growth and rising oil prices. A few weeks prior to that move, inflation as measured by the Wholesale Price Index (WPI) had crossed the 8 per cent mark, something the country had not seen for a long time. Since then, the RBI has raised the benchmark rate twice, in April and October 2005, on both occasions by the same 25 basis points. During this period it has also increased the frequency of the announcements from half-yearly to quarterly. The next announcement is due today.

There is very little in the macro-economic environment to warrant any change this time round. The most recent WPI release, reflecting the situation a couple of weeks ago, put inflation at 4.24 per cent, which should hardly cause concern to anybody. Of course, even if the underlying pressures remain muted, the number itself will go up over the next few weeks because of the base effect"" it was particularly low during the corresponding period of last year. However, that in itself is no reason for the RBI to take an active anti-inflationary stance. The fact is that the Indian economy has been able to grow at around 7 per cent or more for three years at a stretch without provoking significant inflationary pressures. To the extent that inflation has re-entered the policy debate during the last year, it is largely because of the sharp increase in oil prices. While the risks that oil prices will shoot up in the near future remain and have perhaps increased with the recent face-off between Iran and the western world over the nuclear issue, those eventualities can be dealt with as they happen. Meanwhile, domestic financial markets seem to be dealing with demand pressures exactly as they should, by gradual but unmistakable increases in interest rates.

From a global perspective, also, the tendency appears to be towards a wait-and-watch approach on the part of central banks. There are strong signals from the US Federal Reserve that it has more or less reached its target level for the federal funds rate and is unlikely to increase it further in a business-as-usual scenario. In fact, in the current scenario, in which rising oil prices are the most significant risk, a slowdown in growth is perhaps the more likely outcome over the next year or two. Concerns about this have already been aired on the basis of the inversion in the US yield curve""long-term rates being lower than short-term ones""that has taken place in recent weeks. Even if this possible slowdown is accompanied by rising inflationary pressures, it would be difficult to deal with it using the uni-dimensional instrument of interest rate increases. Taking all these factors into account, the best thing the RBI can do today is to make today's announcement truly a non-event.