This week’s news has been resoundingly depressing. Prices continue to be on a tear, wholesale inflation in August was an eye-popping 9.8%.
Oil prices remain high, and the hike in petrol prices by Rs 3 a litre does not capture the full extent of the surge in global crude prices and the increasing weakness of the rupee that is making energy imports costlier than they should be. Factory output is slowing: it grew a mere 3.3% in July, but the economy is not cooling down fast enough to rein in prices.
The week’s data set reinforces the Reserve Bank’s determination to keep sucking out liquidity from the financial system to arrest self-fulfilling expectations about accelerating prices. Friday’s hike in the rate at which the central bank lends overnight money to banks takes the cumulative increase in interest rates to 3.5 percentage points since March 2010.
The RBI’s assessment of credit conditions and the fiscal position offer room for further tightening of monetary policy. Money supply and non-food credit growth in August remain above central bank targets. This despite banks passing on increased interest rates to borrowers: banks, on average, increased lending rates by half a percentage point immediately after the RBI hiked the policy rate by as much in July.
The fiscal deficit has yawned in April-July 2011 as revenues have declined while fuel and fertiliser subsidies ballooned. The government has run through half its budgeted deficit in under a third of the current fiscal year. Yet the strongest signal for more interest rate hikes is available in the central bank’s resolve to bring inflationary expectations to heel. Monetary tightening over the past year has worked in anchoring expectations, and a premature change in stance could dilute the impact of past actions, the RBI said after Friday’s policy review.
Eventually, the central bank wants to reach a point where companies across the spectrum lose their power to pass on rising raw material costs to consumers. In this the government appears to be on the same page. The RBI has had a free run so far despite wails from industry and borrowers. The central bank is relying on India’s greater dependence on domestic consumption to pursue a hard landing amid fears of the world being pulled back into recession.
A helping hand from the government would be appreciated. Freeing the administered prices of a host of products from food to fuel can help shift demand from the government to more productive investments by companies and households. Fixing supply bottlenecks in agriculture and infrastructure, likewise, can ease structural inflation, for which monetary policy has no answers.