RBI pulls back for now, but may raise rates later
While the Reserve Bank of India has taken the common man by pleasant surprise by not raising interest rates during its December policy review, the relief is unlikely to remain for long if the Congress-led UPA Government fails to control inflation. Since taking charge as the bank's Governor in September, Mr Raghuram Rajan has twice raised the interest rates in the hope that it will balance out the inflationary trends which could be brought under check soon. But retail inflation has spiralled since then, touching a nine-month high of 11.24 per cent in November, while wholesale price index inflation rose to a 14-month high of 7.52 per cent. It is clear that the Government has to do a lot more to tackle the menace, and the RBI, by not going in for another raise, is hoping that more will happen. Mr Rajan has expressed the belief that the monetary tightening which the Government had initiated and the fall in prices of vegetables could begin to positively impact inflation figures in the coming months. He also believes that the Centre can contain fiscal deficit to 4.8 per cent of the GDP. let's see. He himself admits that the economy is in a “weak state” and that an “overly reactive” policy measure may not be the best thing. In other words, Mr Rajan would like to wait a while before taking a bigger step. The Government as well as the markets would naturally like the RBI to slash the rates at which it lends money to the banks. But given the RBI's concerns, that does not appear to be an immediate possibility. On the contrary, if inflation is not brought within comfortable levels in the coming weeks, the bank could at best keep the rates unchanged or even increase it by a few percentage points. The latter would be an unpopular step, given that the Government is heading towards a lok Sabha election early 2014 and would not like to further dampen sentiments; in any case, it’s unlikely that the UPA regime can bring about a turnaround in the fortunes of the country’s economy. But the RBI is unlikely to go by political considerations alone, although it works closely with the Government on its policy measures.
Mr Rajan's predecessor D Subbarao had been often criticised for remaining fixated on inflation at the cost of growth, and it had been widely believed in Government circles that the trend could reverse with Mr Rajan's appointment. But the new RBI chief has shown no inclination to launch populist measures. Although he has reiterated on many occasions that growth must be promoted, he has also understood that growth without the containment of inflation is meaningless. Indeed, growth without an effective mechanism to check inflation could add to the inflation figure. Mr Rajan has a tough balancing act to do. He cannot entirely ignore the wishes of the ruling class because he has to work in tandem, and yet he has to do what he and the RBI think is appropriate to regain the health of the economy.