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Business News/ Politics / News/  Central bank sets the stage for tough calls
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Central bank sets the stage for tough calls

Central bank sets the stage for tough calls

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Expect a further hike in interest rates and an increase in the balance that banks have to maintain with the central bank.

That was the message between the lines in a document released by the Reserve Bank of India (RBI) to set the context for the annual credit policy it will announce on Tuesday. In the last financial year, the bank raised the short-term lending rate five times and used other monetary tools to reduce money supply.

Titled Macroeconomic and Monetary Developments, the document says that the real interest rate (the lending rate adjusted for consumer price inflation) dipped marginally from 1.6% in March 2006 to 0.2% in March 2007. That would mean that the inflation rate has risen at a much faster pace than the central bank’s key policy rate. The real interest rate in India is much lower than it is in countries such as Brazil (9.8%), Indonesia (2.5%), Israel (4.8%), the Philippines (5.3%), Russia (3.4%), and Thailand (2.5%).

“The conduct of monetary policy would continue to demonstrate that inflation beyond its tolerance threshold was unacceptable and the resolve to ensure price stability was always backed by timely and appropriate policy responses," says the document. In plain English, that translates as: if inflation rises, the central bank will do whatever it can to reduce it, including raising the interest rate.

“Though all speculation will be put to rest tomorrow, the central bank is clearly indicating that there is a case for the use of monetary tools to control inflation and that this is far from the end of the liquidity tightening in the banking system," said an economist with a private sector bank, who did not wish to be identified.

The chairman of a public sector bank, who spoke on the condition of anonymity, said that he did not find the logic behind RBI’s argument sound. “Unlike the US, the policy rate in India does not reflect the market rates. For instance, banks are offering over 13% for deposits. So how do we measure the real rate?" he asked. The policy rate currently stands at 7.75%.

The central bank has pointed out that, over the past year, while consumer price inflation has eased in most emerging markets, it has risen in China, India and South Africa.

Critics of RBI’s monetary tightening efforts have said the central bank can do little to control prices, which are driven by a shortage of certain agricultural products and high raw material prices. The RBI document,however, points out that the contribution of manufactured products to inflation has risen from 27.7% a year ago to 55.9% in March 2007. India’s definition of manufactured products includes edible oil and a few similar products where prices have risen because of short supply.

Abheek Barua, chief economist, India, ABN Amro Bank, said even if edible oil was excluded from the manufactured good category, “the share of manufacturing in inflation has still gone up substantially." He added that this meant “the central bank can affect prices by controlling demand."

KEY MACROECONOMIC INDICATORS: EMERGING MARKETS (Graphic)

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Published: 24 Apr 2007, 02:09 AM IST
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