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S. Balakrishnan

Stock indices have multiplied more than fivefold in the last three to four years. Real estate and property prices have also escalated as much. Yet inflation has behaved.

Will the RBI hike rates again?

It is the `big' question facing Indian financial markets.

As usual forecasts differ. Some predict another increase in January, when the quarterly review of monetary policy is due, while others think it will stay its hand.

The stance of the central bank would obviously depend a lot on inflation, which, at 5 per cent +, is a lot higher than in the G-7 economies as well as China. In fact, quite a few `third world' countries have lower inflation compared to India. But there is probably not much scope to reduce it significantly at modestly higher interest rates. With sharp rate rises, the growth sacrificed is likely to be much more than the inflation `gain'. Thus, bringing down inflation to G-7 levels is not a worthwhile goal.

One would, therefore, expect that the RBI will not move on the rate front in the near future, unless there is a marked deterioration in inflation.

So is all well? Unfortunately not. Conventional measurements of inflation do not capture the dynamics of asset prices. Does it matter?

Take the Indian situation. Stock indices have multiplied more than fivefold in the last three to four years. Real estate and property prices have also escalated as much. Yet inflation has behaved. Does it mean they are not connected? More important, does exclusion (of asset prices from price indices) mean irrelevance?

Alan Greenspan, the previous Chairman of the US Federal Reserve, fudged the answer to these questions. He thought the Fed was in no position to pass judgement on asset prices. Mervyn King, the Governor of the Bank of England, worried about the borrowing and leverage involved in asset financing. A market crash could leave the financial system exposed.

To its credit, the RBI is well aware of the problem. It has consistently warned banks against overextending themselves in capital market, real estate, property and housing finance and increased the risk weights for these assets.

Of course, for most, protecting the health of the financial system is an abstract issue. Life in urban India, already a hellhole for even the middle class, will become more so with decent housing becoming unaffordable except for the rich and super-rich and those lucky enough to already own or inherit it. And housing, it need hardly be said, is a basic necessity - remember the saying, roti, kapada aur makaan?

Arresting asset price inflation - if the government thinks it should be done, RBI seems to have no role here - will require punitive interest rates, which is unjustified and bad for the rest of the economy.

Policy challenges to engage the brightest and best minds.

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