Opinion - Editorials   

A pre-emptive move

The Reserve Bank of India's decision to hike the short-term interest rates, announced in the third quarter review of the credit policy, has surprised many market participants. The central bank's logic, however, seems to be sound. Both the short-term rates, the reverse repo (the rate at which the central bank absorbs liquidity), and the repo (the rate at which it lends) have gone up by 0.25 percentage points. The new rates at 5.5 per cent and 6.5 per cent respectively indicate a further monetary tightening, at least over the near term. At the time of the mid-year review of the credit policy in October 2005, the RBI had marked up these rates by an identical margin, bringing the number of such increases over the previous 12 months to three. The RBI, like other central banks the world over, has been influencing the short end of the market leaving the long term interest rates to be decided by market forces. There is a great deal of evidence suggesting a synchronised movement of interest rates by major central banks, although the timing and the magnitude of change have understandably varied. The U.S. Federal Reserve, which has increased the benchmark interest rates 13 times in a row over the past 18 months, is widely expected to ease off soon. That would suggest that the RBI too would not signal further hikes once it is satisfied that its monetary stance is capable of achieving its objectives.

High up in the list has been the need to send out strong, pre-emptive signals to dampen and contain inflationary expectations, to ensure macroeconomic stability, and to sustain the momentum of growth. Of the major risks India faces, international crude prices remain the most challenging. Given their permanent nature and the fact that their full pass through effects have not taken place yet, there is every possibility of generalised price increases occurring soon. The RBI has repeated its earlier warnings of inflated asset prices, caused by excess liquidity. While very recently, following the redemption of India Millennium Development bonds, there has been a drying up of liquidity, it is a fact that an unprecedented increase in credit has caused a great boom in retail lending, especially to the housing sector. It is not clear if a small hike in the interest rate on retail loans — leading home loan companies such as HDFC are contemplating one — will dampen the enthusiasm of borrowers but the RBI's repeated emphasis on maintaining credit quality is highly relevant. Both its GDP forecast for this year and its outlook on inflation remain unchanged at between 7.5 and 8 per cent and between 5 and 5.5 per cent respectively. As always, the monetary objectives are several; they include price stability and meeting the genuine credit needs of the economy. The small hike in the short-term rates is a clear indication that the RBI is now focussed on containing expectations, above all.

Printer friendly page  
Send this article to Friends by E-Mail

Stories in this Section

No more brazening it out
A pre-emptive move
Fight for the middle ground in Britain
Spying game still thriving
Chimpanzees closer to humans than to apes
Energy key in the new Asian architecture
Bigger nuclear weapons will mean less security
Cable TV row
Bihar politics
Karnataka crisis
End cruelty

Copyright © 2006, The Hindu. Republication or redissemination of the contents of this screen are expressly prohibited without the written consent of The Hindu