Living with Inflation: Editorial in Financial Express 26th January 2011

The market was expecting a 25 bps increase in the repo and reverse repo rates. So when invoked, it was more or less self-fulfilling, which also means that it is unlikely to have much of an impact. RBI has also upped its inflation number for March to 7%. Put these two together and we can draw two conclusions. The first is that we will be living with high inflation for the remaining two months, which is probably an honest idea conveyed and second, even RBI is helpless. Less than two weeks ago, the government threw up its hands on inflation saying nothing could be done in the short run and that it was up to RBI to take suitable measures. RBI, in turn, meekly increased rates by 25 bps and left it to nature to take care of the rest. Maybe it was the best that could be done, but the tone of helplessness is significant and probably disappointing as the economic review released a day before made inflation tackling a more serious issue.

Also, RBI has left banks to improve liquidity by dealing better with imbalances in funds, which is surprising. It has cautioned more on banks reconciling their high credit growth with limited deposits backing them. Is there an ALM mismatch? The SLR and OMOs did not quite deliver the result and ideally RBI could have announced direct measures to alleviate liquidity. The implication is that we can expect tight liquidity conditions to prevail in the coming months unless banks are able to play the conjurer’s role and get in deposits by increasing deposit rates further—increased government spending in the year’s last quarter, though, could help. This brings to the fore the issue of lending rates. RBI has maintained that growth is on target, which means that there has not so far been an impact due to higher interest rates. We are betting that the same sentiment will hold for the next quarter, too, which could be the surprise element. Higher interest rates up to a point will not militate against investment and growth, but once we reach an undefined limit, profits are affected and there could be some adverse repercussions. Protagonists of the growth-neutral theory say that as long as demand is there, no one will cut back on production, as it is their business to produce. But, industry has another story to tell, as beyond a point profits come under pressure—especially for infrastructure projects. What exactly is this inflexion point is the moot question.