Not over yet

Uncertainty in Europe and the advanced markets suggests that the world may not be fully out of the crisis yet. While the RBI may be keen on bringing the stance of monetary policy back to a neutral stance,it cannot ignore the difficulties that may lie ahead. Despite the euphoria created by Monday’s news of healthy IIP and GDP growth figures,the RBI needs to have a forward-looking view of the economy. Raising interest rates in response to the clamour of analysts can be counter-productive.

Moreover,inflationary pressures have been coming down as seen in month-on-month inflation rates of seasonally adjusted numbers. While headline inflation numbers in India are still reported as year-on-year figures,unlike in the rest of the world,these do not represent the latest trends. Looking at the latest seasonally adjusted data — which the RBI has started doing,as seen in the recent credit policy statement — suggests that inflationary pressures even for non-food,non-fuel inflation are receding. Lower inflationary pressure along with greater uncertainty suggest that the RBI needs to be cautious about raising interest rates in the economy. Monetary policy affects the cost of capital and the pick-up in investment demand is both recent and small. It will be a mistake to start raising rates sharply and pushing up the cost of capital before there is clear evidence of overheating.

Further,with the turmoil in the European debt market it is not certain that capital will flow into emerging economies at the rate that was being expected. If that does not happen,the pressure on the rupee to appreciate will be low and the advantage that Indian consumers could have obtained from a stronger rupee will no longer be as probable as before. At the same time the Indian economy,with its higher growth rate,stabilising inflation and relatively higher interest rates,will continue to attract capital — just as a high-growth economy should. RBI Deputy Governor Subir Gokarn’s view that the RBI will not influence the direction of the rupee will play an important role in the days to come. If the rupee appreciates it fulfils a contractionary role similar to higher interest rates,by contracting demand for tradables and reducing price of tradables. But at the same time,it does not raise the cost of capital. What one has to hope for is that healthy growth brings capital into India.