Will the rate hikes work?

If the Reserve Bank of India's mid-quarter review reveals anything, it is that the central bank is not the only policymaker doing something to tackle the persistent menace of inflation while also aware of the effects on growth of monetary tightening. That is why the repo rate hikes are minimalist in nature; but the fact that this is the seventh time the central bank has raised its key short-term rates this fiscal, and given the strong hints that it will persist with similar moves, the bank sends out a contrarian message to various stakeholders battling food and commodity inflation. The RBI comforts them with the assurance that GDP is set to reach its above-8 per cent target; but the sneaking suspicion is that its serial rate hikes will work more to dampen growth sentiments rather than inflation.

It is also clear that the fault lies not so much in the instruments the central bank uses as in the failure of public and fiscal policy to plan enough to combat domestic supply shortages. No one could have foreseen the turmoil in West Asia and North Africa, but it is a crying shame that India still remains so dependent on these sources for its crude oil. China has, over the last decade, diversified its oil sourcing into Africa and Latin America and beaten India to Myanmar's rich gas reserve five years ago, a piece of strategic foresight that reduces the supply uncertainties. The failure of Indian public policy to address the long-term concerns of a growing economy, therefore, lies at the heart of a spreading anxiety about the cumulative impact on investments and consumption of the small but persistent spikes in key rates. The RBI's review complains about the volatility in industrial production and the “weak performance” of capital goods that, in turn, underline a fresh worry. The services sector may be doing well but a strong growth trend depends on fresh rounds of investment in long-gestation projects. If interest rate costs pile up — and the central bank hints at further hikes-- investors will hold back core project funding or seek outlets in countries with more vibrant public policies for infrastructure.

And now, given that the auto lending rates are inching towards the highest level in five years, the hikes will also impact demand for a product that virtually drove the economy upwards.

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