The Hindu Business Line : Interest rates: The ‘unimportance’ of inflation

The Government has announced its borrowing programme for the first half of the current financial year, frontloading the market resource-raising exercise. Early days yet, but there has been no strong adverse reaction in bond yields.

Inflation is not increasing, even going by the Consumer Price Index (CPI). For the ‘official’ measure, the Wholesale Price Index (WPI) is actually declining. Not surprising. The Indian WPI is basically a ‘cost of living’ index for manufacturing and everyone knows the prices of industrial raw materials are down sharply amidst falling global industrial production and capacity utilisation.

Which leaves us with food. Rainfall is deficient and there is little doubt agricultural growth will suffer this year. The big question is how much it will affect the prices of daily necessities.

Food stocks are comfortable and shortages can be imported away. There could be abnormal price movements in select primary articles because of temporary supply shortfalls, but no reason to fear an all-round sharp upsurge in prices.

If inflation is in control, is it the end of the story for interest rates? It would appear so. The sheer size of government borrowing frightens markets, but given the enormous liquidity injection and the obvious jump in bank deposits, there is no real constraint. It is, in fact, already reflected in banks’ excess investments in government securities.

‘Surplus liquidity’

What, therefore, should cause worry? It is the possibility of the Reserve Bank of India deciding enough is enough and withdrawing its largesse, that is, ‘surplus’ liquidity from the market.

The issue is whether it will wait for inflation to turn ‘ugly’ before it acts. Central banks are known to (and have) act(ed) pre-emptively. It is a difficult guess.

Though the RBI’s monetary policy leeway has increased enormously in the recent years, on paper it is not an independent central bank. (In the context of the present — or any — economic and market crisis, some might say the whole idea is a myth.) So, the stance of Government will inevitably carry much weight.

That stance, echoed in the recent Budget, is clearly pro-growth and never mind the deficit. The attitude is the bridge can be crossed when we come to it. It doesn’t mean the Government is indifferent to the issues involved. It, as indeed the RBI, must be waiting to see if the current growth momentum is maintained. Besides, with elections out of the way, the Government is not as much a hostage to the electorate as before.

Sustained satisfactory growth, with or without an increase in inflation, even if falling short of the boom years, will be the signal for the RBI to ‘exit’ its soft policy with the nod of the Government.

More Stories on : Economy | Interest Rates | Financial Scan

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page