On a wing and a prayer: Only this explains the RBI move to jack up rates

By raising the repo rate, the RBI has sacrificed growth and investment to try and contain inflation, which even the government says, has been driven by external factors

So the government and the RBI have decided to sacrifice investment/growth to control inflation on the one hand and reduce the outflows of dollars on the other. To this end, they have increased the price of money in India.

Will they succeed in both, in one or the other, or fail in both? The question has to be answered in the context of the RBI’s own projection that inflation will be 6.7 per cent in FY23. If that’s what the RBI expects, the actual number is likely to be quite a bit higher. So the first target of the hike in rates has already been missed.

The finance minister has been stressing that the current bout of inflation is because of external factors, namely, the Ukraine war. Hence the concern: how do you dampen imported inflation with such a steep domestic rate hike? The move may well work, but there is no guarantee.

To add to this confusion, the RBI governor has said that the current dollar outflow crisis is also because of external reasons, namely, the “super aggressive” monetary policy of the US, which is raising its domestic rates rapidly, thus sucking in dollars into the US.

India, by the way, is not the only country at the receiving end of this US policy. All countries have been similarly affected. India, in fact, has been less badly affected.

Be that as it may, here’s another question: two external problems are being tackled with one domestic instrument. The government will have to be very lucky to stem both inflation and the outflow of dollars.

To add to the problem of inflation that comes from excessive government spending, the free foodgrain programme has been extended. It will be surprising if this turns out to be the last extension. Politically it’s going to be very nearly impossible.

It is also hard to understand how, when all the evidence points to the contrary, the government and the RBI believe that monetary policy — and more specifically, interest policy — can quickly work as a sledgehammer on macro problems when it is actually just a goldsmith’s tiny hammer.

This leads to two questions. First, did the RBI raise rates so steeply because it wants to be seen as a firm central bank and not a ditherer “behind the curve”? Second, more baldly, is it simply out on a wing and a prayer? Or a bit of both? After all, the RBI governor has frequently spoken about the uncertainties of the times.

Last but not least, there is the happy sacrifice of growth. Through some dodgy arithmetic, the RBI thinks it will be 7 per cent this year. This is lower than earlier projections.

This sacrifice of growth and investment has been made in the face of repeated pleas by the government to the private sector to raise the level of investment. In the last eight years, 80 per cent of new investment has come from the public sector. But now, it is doubtful if private investment will recover in the remaining years of this government’s second term until 2024. This means — not to put too fine a point on it — a higher fiscal deficit and a higher propensity for inflation.

I hope I am completely wrong and that this policy succeeds and all its objectives are met. But, as I said above, we will need a lot of luck. That, however, as history shows — even in China — tends to run out in a government’s second term.