The Hindu Business Line : Focussing on gradual growth

With the 25 bps CRR hike coming on the back of a 50 bps hike a few days ago, the Reserve Bank of India has once again clearly signalled that it prefers calibrated growth rather than runaway inflation.

However, with a status quo on the repo and reverse repo rates, indications are that growth remains a priority, albeit not the topmost one.

Main challenge

The biggest challenge before the RBI currently is that of managing the relationship between growth, inflation and currency.

Taking steps to moderate inflation, to keep it within the 5 per cent level, without significantly impacting growth while managing currency concerns remains a tough test. This is especially so given that the money supply has been consistently high and is likely to continue to be so for a while.

When the RBI held interest rates during the January policy announcement, there were concerns that growth was being jeopardised. But so much has changed since January that in retrospect it is clear that the RBI was justified in its actions.

Growth rates

The recent CRR hikes, in spite of concerns of an economic slowdown, appear to reflect the RBI’s thinking that while the growth rate has been revised downwards, even at 7.5-8 per cent the economy will still be growing at a reasonably good rate.

Coming at a time when major developed economies around the world face the possibility of a recession, these growth estimates look even more attractive.

Given that the current bout of inflation is primarily supply-side in nature, there is a view that it will be difficult to control it with monetary policy action.

However, a closer examination shows that inflation is not wholly supply side in nature. There are capacity constraints resulting in demand related inflationary pressure on prices. Though agricultural prices cannot be controlled by way of monetary action, industrial demand can certainly be controlled.

Arbitrage opportunities?

India’s high interest rates on the backdrop of falling interest rates in several developed markets have led to fears of arbitrage opportunities being created.

The point that is missed in this argument is that with inflation at 7 per cent, the real interest rates in India are actually lower.

Over the next few months, the RBI will watch the impact of the measures it has announced now.

But the Credit Policy statement is unambiguous in stating that the priorities remain price stability and “well-anchored” inflation, and it is equally clear that the RBI will quickly respond to developments that affect either of the two.

If inflation is not reined in by the monetary and trade policy measures, inter-policy action cannot be ruled out.

(The author is Fund Manager, Fidelity Cash Fund, Fidelity Multi Manager Cash Fund and Fidelity Short Term Income Fund.)

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