At this rate

With the prime minister8217;s economic advisory council saying the inflationary effect of the fuel price hike will not be alarming, with latest inflation figures modest and with the affordable credit as vital for the real sectors of the economy as it has been for some time, it is a little hard to understand why the RBI thought an anticipatory rate hike would be a good idea. If the answer is that RBI must keep an eye on and move in step with corrective measures undertaken by Western monetary authorities, we must argue, as we have consistently done before, that the central bank should reduce the importance of currency rate management in its policy portfolio.

In economies that are open, monetary authorities lose effective sovereignty over interest rates if they are keen to maintain their currency within a certain preferred range. That is, if the RBI wants, as it does, to make the rupee 8220;behave8221;, it cannot but follow Americans when they hike their interest rates. It makes a great deal of sense for the RBI to be less hyper about the rupee and thereby allow itself greater elbow room over interest rates. India doesn8217;t need to hike rates every time the US Federal Reserve does 8212; that way rate changes will be much more in tune with domestic macroeconomic realities.

One of the realities is that overall good corporate performance hides many non-behemoths reporting less-than-pleasing results. Clearly, cost of funds will be crucial in this context. There8217;s the example of 1996, when rate hikes produced a recession. India has had three years of 8 per cent growth. Some of the markets, for stocks and real estates, most prominently, became too exuberant perhaps in this time. If one assumes that a correction is under way and will continue for some time, and that economic agents will therefore adjust their expectations, it is still wholly rational to expect, say, GDP growth of 7 per cent from this economy. The question is whether the RBI sees that.