Percentage voters

Over the last one year, monetary policy has added to the woes of middle class households in two ways. Not only has the Reserve Bank of India failed, owing to its inconsistent monetary policy framework in keeping inflation under control, but it has also, by raising interest rates sharply, increased the burden of EMIs on the aam aadmi. Whether for home loans, or for borrowing for automobiles or other consumer durables, EMIs have become a part of the monthly expenditure of middle and lower-middle class India. The RBI can blame expanding Chinese consumption and oil producers for higher world prices but it cannot blame them for higher EMIs for Indians. Indeed, countries such as China have been keeping interest rates low. This was done mainly to prevent high capital inflows being attracted on account of positive interest differentials. In India this would have served a double purpose, as households which are already looking at high food prices would have got some relief. And, lower interest rates would have resulted in less pressure on the rupee and less intervention and its consequent sterilisation by the RBI. The latter has added to the environment of higher interest rates in the Indian economy.

Urban India today is affected not only by food price inflation but also by EMI inflation. Today, not only is it bad economics to counter supply-driven inflation by raising interest rates, but it will be a political mistake as well. The urban middle classes do not benefit from a food price rise as some sections in rural India 8212; who are net producers of these crops 8212; do. Since they only lose and don8217;t gain in any way from the inflation, an interest rate hike in an environment where they have already been suffering from high interest rates for more than a year now will put further strain on their budgets. In addition, those whose livelihood or whose employers are dependent on bank borrowing for business would suffer if there is an interest rate hike.

The best policy option to control inflation at this point would be to reduce import duties and let the rupee strengthen. Knee-jerk reactions like banning trade in various items or raising rates and postponing cuts would be a mistake. While rural India has got a loan waiver, if the government cannot give urban Indian middle class households a loan waiver too, it can at least try not to create conditions in which urban households are pushed into default.