RBI finally turns hawk

RBI finally turns hawk

Mumbai: Finally, the Reserve Bank of India has given up its baby step approach to combat inflation. A 50 basis points hike in policy rates was much needed and was long in coming.

What’s more significant is the statement – for the first time in recent years – that the central bank was willing to sacrifice some growth to fight rising prices. That’s all the more important because supply-side constraints, which have been responsible to pushing up prices, are unlikely to go away overnight. To cite just one example, nearly a third of food output in the country rots away due to improper storage and transportation facilities, but a new logistics system will take years to build. Thus, the central bank had no option but to curb demand.

While growth had slowed down, it is still chugging along at 7-8% rates. Demand side pressures are picking up as well. History shows that whenever the economy has come exceeded a 9% growth rate, it overheats and inflation surges to double digits.

The interest rate hike looks certain to affect investment demand for one. As evident from the IIP and purchasing managers’ index (PMI) numbers, capital investments are already slowing down.

This willingness to sacrifice some growth is in a way at loggerheads with the government. The finance minister is gambling on a 9% growth this financial year to balance his books and bring the fisc under control. Now, the central bank is projecting a softening of growth to around 8%. This one percentage point difference in the government and RBI forecasts is perhaps the widest in recent memory.

The central bank’s projections seem sensible and it won’t be long before the government revises its projection, as Mint’sSanjiv Shankaran points out.

But what is the minimum rate of growth acceptable? With the central bank projecting inflation to peak at 9% by the first half of the current fiscal, this is not the end of the rate hike cycle.