In a post March this year (http://senkonomix.blogspot.com/2011/03/amusing-love-for-inflation.html), we were amused with the high deree of tolerance of high rate of ination in the previus three years. Since then the Reserve Bank of India have further strengthend its anti-inflationary polcy with interest rate hikes in May and in July. With this, the RBI maintains its ec growth projection for the year ending March 2012 at 8% but now projects a7% infation rte - 100 basis points hiher than its projection released in May.
For the layman, it is amusing to know that a 100 basis point higher inflation means no reduction in economic growth rate. Equally interesting, this will be accompanied by, on present reckoning, a rise in interest rates by 275 basis points or so (already banks have transmitted 225 basis interest increase in the first four months of the current fisc). So, what will cause higher inflation - external factors and higher interest rates or higher fiscal deficit. This or high profile economists to explain: most likely consesus -: all these factors will increase inflation to varying degrees.
Yet, these inflation, economic growth and interest rate projections may have to be revised again soon, the RBI apprehends, if the petroleum oil and other commodity prices do not ease in the international markets, if the monsoon does ot favour a bumper crop in India, if the government does not take adequate supply augmentation policies in time and if the fiscal deficit of the Government of India exceeds the budget target of Pranab Myukherjee. so, inflation rate may be higher than 7% and interest rates may have to be hiked further by the RBI.
RBI is partivcularly worried that the demand pressures, though somewhat moderated in some of the highly interest senstitive sectors as a result of the 225 basis point rise in modal lending and deposit rates, continue to be strong in most sectors. So, the repo and reverse repo rates were raised by 50 basis points on July 26: this the RBI expects to further weaken demand pressures in more interest senstive sectors as well as the less interet sensitive sectors and reduce money supply growth by 50 basis points to 15.5% and non-food credit by 100 basis points to 18% in 2011-12.
It would seem to the layman that the RBI would be comfortable if the economic growth rate declines to say 7% or lower and inflation rate to fall to 6% or lower. Otherwise RBI may again raise the lending and borrowing rate to pull down the economc (GDP) growth rate. But even if growth rate falls below 8%, RBI may be stil forced to raise interest rates if monsoon does not deliver bumper crops, and/or international commodity prices rise and/or fiscal deficit targed is exceeded by say 50 basis points or more. So, we are going to be in high interest regimes.
Unfortunately, higher inflation will automatically icrease working capital requirements and demand remais strong, higher inteest rates may still be absorbed. This may lead to higher interest rates again. On the other hand, if the monetary policy succeeds in bringing down demand and GDP growthm and banks face creditt defaults, RBI would do something to ease prudential norms temporarily to stem any financial sector instability. Te best thing for the layman there fore is to tighten the belts and pray to God that there is a bumper crop (and bulginng food credit) and a fall in world commodity prices. Tere is no point in praying to the Government as government is incapable of reducing expenditure growth and in no mood to reach the fiscal deficit target. Only hope is that the lower GDP growth may still lead to highly bouyant growth in tax revenues - better than what the government had optimistically budgetted for because of reduced leakages and higher value of sales.
God RBI will not relent till inflation rate shows consistent down trend even if higher interest rates contribute to slightly higher inflation temporarily. Let us keep our fingers crossed.
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