No time to pause

Mint Road and North Block have promises to keep

To pause or not to pause? That is the question the Reserve Bank of India (RBI) faces in the run-up to next week’s monetary policy statement. While professional opinion is sharply divided, and not just between the traditional monetary policy sceptics and loyalists but also across a wider spectrum of professional opinion, business opinion is united in its opposition to a rate increase at this time. Business persons in the manufacturing and services sectors, including the financial and banking sector, are urging a pause on the grounds that further hike in interest rates would have a debilitating impact on an already slowing growth rate. While the government’s macroeconomic authorities still hope to see fiscal 2011-12 deliver a growth rate of eight to 8.5 per cent, many others see growth slipping well below eight per cent. In itself, this slowdown is not serious enough to set alarm bells ringing, but it would strengthen the opinion that nothing should be done that may further slow the economy’s growth rate.

On its part, the RBI laid out all its cards on the table through its mid-quarter policy statement in June when it stated that “the monetary policy stance remains firmly anti-inflationary, recognising that, in the current circumstances, some short-run deceleration in growth may be unavoidable in bringing inflation under control”. Of course, the RBI hedged its position by adding a caveat towards the end of the statement: “The extent of policy action needs to balance the adverse movements in inflation with recent global developments and their likely impact on the domestic growth trajectory.” Between then and now, global economic developments have become more worrisome. Brinkmanship in policy in major developed market economies on both sides of the Atlantic has pushed the global economy back to the precipice. Should India’s policy makers do anything that may further dampen the animal spirits of domestic enterprise at a time when the global economy offers no signs of hope? At home, the monsoon has so far been near normal but not exactly reassuring. Is it better to wait for another six weeks to figure out how the monsoon is likely to impact growth and inflation?

These questions are bound to engage the attention of India’s central bankers as they sit this week to figure out what is to be done next week. On balance, however, it would seem that the market expects a 25-basis point (bp) increase in policy rates next week. It is most unlikely that the RBI would want to go against such market expectations and press pause at a time when concerns about inflation are as acute as those about a slowdown in growth. If the RBI has to err, it would prefer to err on the side of caution than bravado. A cautious approach at this time would mean staying with at least a 25-bp hike. A 50-bp hike would be tough action, and some have recommended it. But the overall mood of policy makers in Mumbai and New Delhi suggests they may shy away from such tough action. So, expect a 25-bp hike.

It is obvious that monetary policy alone can no longer rein in inflation in India. The fiscal authorities at the Centre and in states must rein in fiscal and budgetary deficits. The supply side needs easing through administrative and policy reform. This will help revive the animal spirits of enterprise. Union Finance Minister Pranab Mukherjee has promised to play his part — and he must.