Our interest on his mind
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Our interest on his mind

The RBI rate hike is to tackle an overheated economy, and keep hot money out.

india Updated: Nov 02, 2010 22:57 IST
Hindustan Times

There's a high-stakes poker game on among central bankers this Diwali. In the pot are billions of dollars that will move from the US, Europe and Japan every time a frontline emerging economy raises its interest rates. Reserve Bank of India Governor Duvvuri Subbarao is acutely conscious that his efforts to tame inflation at home can be stymied by a gush of dollars from a West desperately trying to spend its way out of recession. On Tuesday, Mr Subbarao raised overnight interest rates by a quarter of a percentage point, the sixth time since January. On Wednesday, US Federal Reserve's Ben Bernanke, is likely to feed an extra $500 billion into the US economy. A part of this dollar deluge will wash up in India. Already, the yield of Indian sovereign debt maturing in a decade is 5.5 percentage points higher than that of a 10-year US treasury bond. Effectively, banks can borrow in the US and lend in India to earn 5.5 per cent risk-free interest. They have done this with gusto: since January, $10 billion have flown into rupee debt. And the gap widens every time Messrs Bernanke and Subbarao play cat and mouse with interest rates.

Neither, of course, can be faulted. Mr Subbarao is battling an overheating economy while Mr Bernanke is struggling to pump life into a cooling one. The RBI's second quarter review of monetary policy sees India growing near its trend line but food inflation has not moderated in line with a good monsoon — it declined from 21.4% in May to a still worrisome 15.7% in September. Part of the reason is a structural shift: Indians are eating more proteins, which have seen a significantly faster rise in prices. Mr Subbarao's assessment of future inflation is shaped by how food prices behave, the increase in global commodity prices and demand pressures at home as more industrial capacity gets used up. Since his policy toolkit has a fix for only the last variable, Mr Subbarao says chances of further rate hikes look dim.

A country importing $13 billion of goods in excess of what it exports can't afford to turn its back on the $25 billion investment foreigners made in Indian stocks this year. Mr Subbarao is, however, upholding tradition when he tries to ensure that hot money does not leech into the real economy. Stocks, gold and property are at record highs. The RBI's focus on real estate is natural, considering it is a largely home-grown bubble. Thus banks have been made to keep aside more money for lending against expensive house mortgages and for trying to drum up demand through teaser home loan rates.

First Published: Nov 02, 2010 22:54 IST