Inflation has been rising faster than interest rates in India. Real interest rates are now well into negative territory because of this, suggesting that monetary policy is too loose. The Reserve Bank of India will have to increase interest rates.
China has already decided to increase statutory reserve requirements for its banks sharply, by 100 basis points. A few other central banks in the region have also begun to nudge up the cost of money. The rise in inflation and the drop in the rupee against other currencies should be met with higher interest rates. That’s textbook stuff.
There will be collateral damage. RBI had estimated in 2002 that 1 percentage point rise in interest rates cuts the growth rate by 2 percentage points. But inflation is the bigger problem right now. Vietnam is now facing street protests and potential financial trouble because its inflation rate has crossed 25%.
India is not Vietnam. But that does not mean that inflation should be taken lightly. It, thus, makes sense to tighten monetary policy in the coming week or two.