When you give a gun to a soldier and then send him into battle to fight an identified enemy, he’s bound to shoot. So those who blame the Reserve Bank of India (RBI) for shooting by increasing interest rates in its declared battle against inflation are of course being unfair. Monetary policy is the only credible weapon in the central bank’s armoury and it is bound to deploy it. A central bank can squeeze out liquidity from the market in a variety of ways and raising interest rates is certainly one of them. The RBI must expect medals for soldiering on, even though it has not yet fully vanquished the enemy, and must wonder why so many are throwing darts at it. It is in recognition of this fact that this newspaper has backed the RBI’s rate hike moves for most of the last few months. However, at the time of its last policy statement we expressed for the first time in more than a year our doubts as to whether further rate hikes were worth the pain. At that time, as has since been revealed by the RBI itself, the central bank’s external policy advisory group had in fact advocated a pause. RBI Governor Duvvuri Subbarao chose to ignore that advice on the grounds that he was not convinced that he had broken the back of inflationary expectations and was duty-bound to deploy firepower. Since then professional economic opinion, with the almost singular exception of his monetarist predecessor, C Rangarajan, currently chairman of the Prime Minister’s Economic Advisory Council, has increasingly joined the naysayers on interest rate hike.
While many analysts think that the RBI governor is not going to let go, and a great majority of economists want to see inflationary expectations further blunted and price levels lower, the vote in favour of a pause in the rate hike cycle is gaining popularity. Apart from business and trade, bankers and other policy makers feel the government must act on other fronts, especially fiscal. An important factor that is making the “pause” argument stronger is the current environment of global uncertainty and fears of recession. While “business” may be “better than the mood”, the fact that the mood is so downbeat is beginning to worry many players.
A pause in rate increases, with adequate warning that the hike cycle may be resumed without warning and that the RBI will remain hawk-eyed and keep its finger on the trigger, may help improve the mood. This may be a risky strategy, but given the global environment it is a risk worth taking. Long-distance runners know that a pause for a breather is not likely to come in the way of their winning the race. Finally, if the RBI liberates itself from this six-week cycle of making policy statements, it may feel less obliged to act every six weeks. This being the Deepavali week, the central bank can light up the markets with a pause.
