Problem of perspective

Reading the first quarter review of the Credit Policy 2011-12 and its curtain raiser, the macro-economic survey of the economy, one could be forgiven for an initial confusion about the rationale for its current upward adjustments in the repo rate of 50 basis points that now stands at 8 per cent. The reverse repo rate has been automatically adjusted upwards to remain 100 points below the repo rate at 7 per cent; the current increase in the repo rate is similar to the hikes carried out at the time of the last mid-quarter review in early May. The RBI informs us that it has been forced to take this position because of the persistence of demand pressures that have been higher than expected, largely on account of non-food, manufactured goods prices. In the same breath it also tells us that growth has moderated and that it may level out even more if inflation continues: thus, the spike in its key rates, it avers.

The key element in this Credit Policy review, thus, remains inflation that, since last December, has been stoked not just by supply-side pressures but also demand stresses. Step back a minute to let this soak in: the high growth that policymakers in New Delhi are so starry-eyed over has been led by demand that the RBI considers excessive. The central bank (unlike North Block) is worried about overheating; as it notes in its macro-economic review, in the 15 months since March 2010 it has raised its rates by 425 basis points, one of the “sharpest monetary tightenings (sic) seen in the world.” Even though credit growth has consequently slowed, global price spurts “have spilled over in the face of strong demand pressures.” The villain of the piece, it is now clear is not the supply constraints but the excessive demand that has yet to be reined in. The RBI dourly notes that growth may moderate but inflation will stay high through the second quarter too, “before moderating.”

An inflation fuelled by an overheating demand whose steam has been only partially vented poses a real challenge to the central bank. The markets may have factored in repeated rate hikes and such repo rate increases now only evoke yawns; but their cumulative effect is already apparent in a slowdown as interest costs begin to pinch firms. The RBI has warned of high inflation into the festive season which may mean more hikes to tackle that excessive demand the RBI alone seems to dread. Getting the message from the review, one wonders if the New Delhi policymakers are on the same page with the RBI. Given the latter's insistence on above 8 per cent growth, it doesn't seem so.