In whose interest?

RBI governors are supposed to be cautious. But since they are also human, they can err 8212; on the side of caution. Dr Y.V. Reddy raised the reverse repo rate 8212; the rate at which banks lend their excess funds to RBI 8212; by 25 basis points on the apprehension of inflation. But in India, as in most of the world, there are few signs of higher inflation, despite climbing oil prices.

Are higher rates explained by excess liquidity, then? The redemption of India Millennium Bonds at the end of December 2005 was accompanied by a sharp increase in RBI dollar sales. That effort to prevent rupee depreciation led to drying up. Money was, as it were, sucked out. So, a system awash with cash is not an explanation either. What about a system poised to grow? The economy growing at an average of 7.5 per cent can hardly cause fears of overheating when everyone, from the PM to downwards, want 10 per cent growth. So, let8217;s look at global parameters. The Fed is hiking rates in the US. If RBI is afraid that interest rate differentials will lead to capital flight, then signalling for a domestic interest rate hike makes sense.

But that brings up a bigger question: in a large economy with relatively heavy capital flows, can a central bank focus so much on currency management that it gives up monetary policy independence? The question following that is: so, will India be pushed into a slowdown thanks to higher interest rates simply because US central bankers have a certain prescription for the American economy? Europe, remember, has floating exchange rates and therefore can manage these things better. RBI8217;s rate hikes perhaps point to a fundamental rethink in how the central bank priorities its objectives.