The Reserve Bank of India's decision to hike the two short-term policy interest rates, the repo and the reverse repo, by 0.25 percentage point was not unexpected. In fact, macroeconomic developments since the April policy statement suggested a policy intervention even earlier. The relatively small hike in the policy rates suggests that there could be another increase after the July monetary policy review meeting. Economic growth in India has been on a fast track. The official revised growth estimates by the Central Statistical Organisation (CSO) for 2009-10 and the fourth quarter of last year indicate that the economy is consolidating. There is a strong possibility that the various official growth projections for the current year, including the one by the RBI, will be revised upwards. Industrial output in April grew 17.6 per cent over what it was a year ago, aided in part by the recovery in exports. There has been a sharp upturn in the capital goods sector. Further corroboration is seen in the increase in credit and the widening current account deficit. Monsoon rainfall, though delayed in the beginning, is expected to be normal for the season as a whole. However, inflation that jumped to 10.2 per cent in May is clearly the worry. The recent decontrol of petrol prices and the hike in the prices of diesel, kerosene, and cooking gas may add one percentage point to headline inflation. What is particularly worrying is that while food inflation has come down slightly, core inflation, which excludes food and fuel prices, is on the rise.
However, while the case for anti-inflation measures has been very strong, the RBI cannot ignore the concerns of the fast-growing economy. It is this classic dilemma of having to balance price stability with the credit requirements of the real economy that explains why the RBI has been late this time and, by many yardsticks, is still behind the curve. Liquidity was particularly tight during June. Almost Rs.68,000 crore were paid to the government by the successful bidders in the 3G telecom auctions; and advance tax payments drained another nearly Rs.35,000 crore. Certain liquidity-easing measures put in place by the RBI in June are therefore being extended, though for a short period. Easing liquidity, while simultaneously raising rates, is not inconsistent with a policy of calibrated exit from an expansive monetary policy. The latest RBI action has come soon after the banks adopted a new and more transparent method of arriving at the base lending rate. The impact of the RBI's interest rate signals and indeed the efficacy of monetary transmission can therefore be more accurately gauged.
