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Turn the screw a little tighter

Turn the screw a little tighter
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First Published: Tue, Apr 29 2008. 01 11 AM IST

Illustration: Jayachandran / Mint
Illustration: Jayachandran / Mint
Updated: Tue, Apr 29 2008. 01 11 AM IST
Most economists, bankers and bond traders seem to agree that the Reserve Bank of India (RBI) will hike its policy interest rates today. This is in contrast to the consensus we saw three months ago, with strident calls for lower interest rates to tackle the slowdown in economic growth. The spike in inflation over the past two months has changed the consensus view.
Illustration: Jayachandran / Mint
We have argued in these columns for many months now that Indian interest rates are too low and that rising inflation is a bigger threat to the economy than slower growth — even at a time when it seemed unrealistic to do so.
Yet, we feel that there is a valid case for RBI to do nothing at this juncture. The government’s new advance estimates of food production are higher than expected. This could help push up economic growth and cool prices. Global wheat prices are at a six-month low as worldwide production has increased. The first reports on the monsoon are also encouraging. So, there is a case for RBI to wait and gauge the impact of higher food production on economic growth and prices.
The assumption here is that the recent spike in inflation is a temporary affair and is concentrated in a few agricultural commodities. So, inflation will dip with plentiful rain and a few good harvests.
But that’s not the case. The neglect of agriculture over the past couple of decades needs to be corrected with reforms and investments that will take years to do their trick — pushing up supplies and bringing down prices.
At the same time, the US Federal Reserve has flooded the world economy with extra money to stave off a financial crisis there. This liquidity has pushed up global inflation. Unless the Fed unexpectedly reverses course and attacks inflation with a new vigour, other central banks (including RBI) will have to work extra hard to counter inflation.
This newspaper believes that RBI should increase the repo rate — one of its policy rates — by 25 basis points today. The central bank has already decided on 17 April to squeeze credit creation by banks when it hiked the cash reserve ratio by 50 basis points. These two moves should suffice for now.
Meanwhile, watch the words. The RBI governor will also state his monetary policy stance for the year, since he will be announcing the central bank’s annual policy statement. A few tough words will be important signals to the economy and markets.
Should interest rates be hiked? Write to us at views@livemint.com
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First Published: Tue, Apr 29 2008. 01 11 AM IST