The Reserve Bank of India (RBI) has begun unwinding its crisis-induced monetary policy with Tuesday’s decision to raise the reserves banks need to hold in order to lend. Although the higher threshold is meaningless at this point because banks are sitting on government bonds in excess of the 25 per cent required, the signal from Mint Street is unequivocal that inflation is a clear and present danger as the base effect of last year’s record global energy and commodity prices eases and food prices in India ratchet up after a drought year.
The central bank now expects wholesale prices will climb at least 30 per cent faster by end-March than its comfort level of 5 per cent. Inflation far less out of kilter has prompted central bankers in Israel and Australia to raise interest rates as early as August, but Governor Duvvuri Subbarao’s latest assessment is in step with what Finance Minister Pranab Mukherjee described as “the government’s own thinking” on keeping the economy on steroids for a while longer.
Some of the worst-affected sectors have, however, been taken off life support. Special refinance facilities for credit and mortgage companies, mutual funds and exporters, necessitated by frozen international capital markets last year, stand withdrawn. This is an expression of
Mr Subbarao’s confidence that the economy will grow at 6 per cent “with an upward bias” in the fiscal year to March 2010. The higher risk provisioning for loans to commercial real estate is consistent with the RBI’s bank’s long-held antipathy towards incipient asset-price bubbles, even at a time when the government is actively subsidising loans to home owners.
The status quo on the RBI’s policy rates may flatter to deceive. The central bank has voiced its concern about arranging another Rs 1,20,000 crore of debt by February 2010 to fund the Rs 4,10,000 crore the government is committed to spending on social welfare this fiscal year. The easy money came in by September. Government borrowing in the second half of 2009-10 is exerting greater pressure on interest rates as credit demand from the rest of the economy picks up; however, not as vigorously as the central bank had anticipated.
The government may have to, sooner than later, accept higher interest rates as a fait accompli. Policy makers can debate the timing of an exit strategy only as long as the window of opportunity remains open.