The central bank has reached the end of a longish tightening cycle that saw the rate at which it lends overnight money to banks surge by 3.75 percentage points since March 2010. The Reserve Bank's Diwali gift lies in the announcement that it is done for now. Then there is some extra cheer to be drawn from deregulated savings rates. Yet cautionary words accompany the RBI's latest hike in interest rates. Inflation could yet get out of hand, Governor Duvvuri Subbarao, reckons if global commodity prices, particularly oil, do not soften fast enough; if food prices refuse to subside because of weak supply of proteins; if the economy has not slowed down enough; and most damningly, if the fiscal deficit balloons. With this list of caveats, the central bank has retained its projection of inflation by March 2012 to 7%. It, however, sees the persistent hikes in interest rates denting economic output: the projection for GDP growth in 2011-12 is lowered to 7.6%.
Indian companies have lost significant power to pass on rising raw material costs to consumers. In this the government appears to be on the same page as the RBI, which has had a free run so far despite wails from industry and borrowers. With September's hike, India broke ranks with other BRIC nations that have paused monetary tightening. The RBI has followed it up with another one in October. But inflationary pressures at home are far greater than in Brazil, Russia or China. 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.
The RBI's assessment of its own actions over the past year suggests that policymakers will now need to gear up to give growth a push. "As inflation begins to decline, there will be growing room for the policy stance to give due consideration to growth risks, within the overall objective of maintaining a low and stable inflation environment," Mr Subbarao says in his quarterly review of monetary policy. And he is relying on the government to assist in anchoring inflation expectations. Decisions on raising administered prices will raise the price line in the immediate future, but can tease suppressed inflation out of the system. Fiscal rectitude can help steer demand from a bloated administration to 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.