The break in the Reserve Bank of India’s rate tightening cycle could be an indicator that interest rates have peaked, a subject of vigorous debate across the economy over the last quarter. Yet the central bank is emphatic that it is not taking its eye off inflation, which may have dropped into its comfort zone of below 5 per cent but still faces upward pressure from global energy prices and strong consumption and investment demand in the economy. The pause after six interest rate increases in 18 months will come as a breather for a host of industries from automobiles to insurance that were beginning to wince.
RBI Governor YV Reddy has been unrelenting in his vice-like grip on credit. With Tuesday’s half-a-percentage point hike in the portion of deposits banks have to keep as cash to 7 per cent, the central bank signals that although credit growth is slowing, it is not slowing fast enough. Accompanying the third such hike this year, the RBI has abolished the ceiling on the amount it borrows in the overnight market to drain some more of the cash sloshing around in the system. The stress here is not unwarranted. Liquidity management is particularly tricky with the dollar tide chasing the India story having swollen to over $ 10 billion in the first seven months of 2007. Capital inflows on this scale can play havoc with both prices and the rupee. The rupee’s rise has been arrested at nine-year highs but the RBI has had to buy over $ 20 billion between January and May to cap the gains and preserve the competitiveness of Indian exports, most notably software exports. This level of intervention, however, has inundated the overnight call money market, where rates have dipped to zero.
Maintaining its projection of GDP growth at 8.5 per cent in 2007-08 and keeping its view on inflation unchanged at 5 per cent for the financial year, the RBI sees 17-17.5 per cent growth in money supply being in step with both. The first quarterly review of monetary policy thus reinforces the central bank’s conservative position on the economy’s growth momentum. By scaling up the priority attached to liquidity management, Mr Reddy has signalled a slight departure from his previous stance of focusing on growth with moderate inflation.