A Difficult Decision


A very difficult week is coming up.

It is the week when the Reserve Bank of India (RBI) would release some important report on the Indian Economy. All eyes are on the Governor of the RBI, Mr Subba Rao. RBI is the central bank of India, the equivalent of the Federal Reserve or the Bank of England, or the Monetary Authority.

What will he do or not do ?

The interest rates which the RBI has used some 17 or 18 times in the past 21 months to curb the inflationary pressures in the Indian Economy have failed to control inflation. Inflation is still very high at probably around 8 to 9%, while the food-specific inflation has come down significantly for the first time in more than a year.

India is facing challenges from multiple corners of the economy.

India’s trade deficit is rising fast, as the gap between imports and exports is widening every day with oil imports taking the prime place. On the other hand, the Indian Rupee is depreciating fast for as-yet-unspecified reasons, becoming the worst performing currency in the Asia Pacific region, with a drop of over 18% against the US Dollar. This has hugely impacted the importers, Indian tourists overseas and Indian students overseas, while exporters especially the Information Technology companies have benefited.

So, there you go – a widening trade deficit + a worsening currency exchange rate with apparently no bottom + a persistently high inflation + high cost of operation due to the very high interest rates + lack of decision-making at the highest levels in the Indian Central (Federal) Government, all these factors are combining to hit the Indian Economy. The GDP growth rate is likely to fall below 7% despite optimistic government estimate of 7.5%.

With all the above background (and probably much more statistics on hand), what will the RBI Governor do ? My guess is that he will keep the rate steady and will not drop the rate. It is still too early to come to the conclusion that inflation has been curtailed. Of course, he will have to weigh the balance between growth compulsions and inflation. I am sure he will be subtly told by the Finance Minister to consider the growth prospects that would result if the interest rate could come down.

But then, the independence of the RBI has been well established. I have not seen the RBI acting at the behest of anyone. I myself strongly believe that the interest rate should be left untouched for another 90 days till the end of March 2012, before making a decision to bring it down based on further economic data. A softening bias can be indicated now without any adjustments to the various rates. Policy-making at the apex economic level cannot be held hostage to the urgent demands of growth when inflation is eating away any growth.

We are going to wait and see. But I would bet on the outcome I have described above. This would be better for the Indian Economy in the medium term, rather than follow some of the other central banks which have started dropping the rates.

Have a good weekend,

Cheers,

Vijay Srinivasan
17th December 2011
Mumbai

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3 comments

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