Midway into his rate-hiking cycle, Reserve Bank of India (RBI) Governor Duvvuri Subbarao has reason to pause. After raising interest rates for the fifth time this year — bringing the repo rate at which banks park money with the RBI to 6 per cent from 4.75 per cent at the beginning of the year — Mr Subbarao’s monetary stance can be described as neither expansionary nor contractionary.
Overnight money today costs a third less than what it did just before the financial crisis struck India and therein lies the space for monetary policy as the economy, in the central bank’s view, “rapidly converges to its trend growth rate”. How fast interest rates climb from here on will depend on whether the rate hikes thus far can rein in inflation expectations. If wholesale inflation does slow down, as is expected, from 9.8 per cent now to 6-6.5 per cent by March next year, Mr Subbarrao’s softened position will be fully warranted.
One area of immediate concern for the central banker is the negative real rates of interest available in India at this juncture. This has a direct bearing on the slowdown in deposit generation by banks, which in turn affects their ability to lend. The incremental credit-deposit ratio peaked at close to 180 per cent and raises the prospect of growth being constrained by credit unless real interest rates for savers turn positive. On its part, the RBI is nudging up the nominal interest rate. But the denominator—inflation — has to decline perceptibly for bank deposits to become attractive.
Possibly, this could be the window when this occurs. Then again, inflation ran up from zero in April 2009 to 11 per cent a year later and has since then eased only marginally to 9.8 per cent. Banks will need to see a bigger drop before they start offering higher interest rates on fixed deposits, even if their access to the call money market has been tightened by the mere one percentage point band between the repo and reverse repo rates.
The RBI has flagged an issue that merits consideration by the wider policy establishment. The “high volatility in industrial production over the last two months does raise doubts about how effectively the index captures underlying momentum”. Data capture presents a whole range of problems in India that affect key indices from prices to output. While some efforts are on to make the numbers we put out more robust, a lot more needs to be done on an urgent footing.