Those who did not get the message in May when the Reserve Bank of India (RBI) raised policy rates by 50 basis points (bps), ignoring expectations of a 25 bp hike, should get it at least now. By ignoring pleas for a pause this time, RBI Governor Duvvuri Subbarao has clearly shown that he meant business when he said six weeks ago that the central bank will maintain “an interest rate environment that moderates inflation and anchors inflation expectations”. There’s a new gun in town and he’s determined to take on the persisting problem of high inflationary expectations. It was amusing to see those who were votaries of “pause” on television earlier this week forecast another 25 bp hike six weeks from now minutes after the RBI made its announcement at noon time on Thursday. This fact alone should prove that central bank sceptics have finally taken note of the new mood. With hindsight it should be clear to all that last month’s decision to go in for a 50 bp hike was meant to send a strong signal to all concerned that India’s macroeconomic authorities will use monetary policy to fight inflation. Whether they will also use fiscal policy and economic liberalisation as policy instruments remains to be seen.
A second important message emanating from the RBI’s statement that industry must take note of is the reference to pricing power. While not dismissing complaints from the corporate sector about being hurt by rising rates, the RBI has gently drawn attention to industry’s ability to pass on rising wage and input costs to consumers, calling this “pattern” in non-food manufactured products inflation “a matter of particular concern”. The RBI has also called the bluff of the banking sector with many bank chiefs assuring markets that they will not immediately pass on the higher rate increases to customers since they have the cushion to absorb this hike.
By categorically stating that it will continue to raise rates and by rejecting the view that this will have a debilitating impact on growth – conceding though that there could be some moderation of growth and this is a price worth paying – the central bank has left no one in doubt about the direction of monetary policy in the medium term. The one important information that will be available six weeks from now, when the next policy statement is due, is the data on monsoon. By July-end, the monsoon picture will become clearer, which would shape expectations and, therefore, policy. The RBI would be well advised to return to its quarterly timetable of policy statements, dumping the current six-week calendar that the International Monetary Fund sold to it as a pro-market initiative. Given the clarity with which the RBI has made inflation control its main policy objective and considering the determination with which it is pursuing this objective inflationary expectations should begin to moderate. Even if a fuel price increase pushes up energy prices, it need not automatically translate into cost-push inflation, especially if the demand pull gets weakened. Stabilising growth at home is even more important at a time when the global economy is once again a bit wobbly.
