Never in recent history has a week been so important for the world and for domestic economies as this one. On Friday, Reserve Bank of India (RBI) governor Raghuram G Rajan will present his maiden monetary policy review. While most in India will keep a close eye on forward-looking cues on how and when the RBI will announce lending rate cuts, the world and Mr Rajan, will have another question: how soon will the United States turn the tap dry on the flow of ultra-cheap funds? The action that Fed Reserve chief Ben Bernanke will probably take on September 17-18 on the scale back of an easy money policy in the US will determine the course for the RBI and most of its emerging world counterparts. On Monday, India’s wholesale inflation data confirmed what most households have been complaining: cost of food items were on the rise.
A six-month high wholesale inflation of 6.10% in August has added to the array of problems for the government battling to steer the country out of an economic mess. The UPA faces a potent mix of high inflation, a falling currency and poor economic growth at the worst possible time — key state elections will take place in the next few months, and general polls are less than a year away. High inflation means that the RBI will hesitate to cut interest rates, a step needed to boost economic growth. So consumers need to keep paying large chunks of their income every month towards repaying housing loans, even as the cost of food and petrol rises and the prospect of decent salary hikes recedes because the economy is struggling. Making borrowing more expensive by raising interest rates may address the issue of higher prices and would help arrest a fall in the rupee, but would likely hurt growth further, which slowed to a four-year low of 4.4% during April-June.
It may be tempting to conclude the bottom may not be far away for the economy after factory output grew 2.6% in July after successive months of contraction, but the next couple of months will have to bring in fairly good numbers for industrial output to be out of the danger zone. Besides, consumer goods — which have been the arrowhead in the demand surge over the previous decade — are still not out of the rough cycle. Ahead of the festival season, high borrowing costs will dampen purchases of consumer goods that are mostly bought through loans. Ordinarily, only points of inflection in economic cycles necessitate a realignment of policy. But these are extraordinary times, and the government and the RBI will have to recalibrate their responses sooner, rather than later.