Signalling concern: Financial Express Editorial 16th March 2011

The curious thing about monetary policy is that it has to not only be forward looking but also be either ahead or behind the market to have an impact. When the monetary authority does something what the market already expects, and is hence buffered, then the policy action is not quite that effective. So is the case with RBI’s monetary review—the last for the year on March 17. Under normal circumstances, this should not matter, considering that we are in the last fortnight of the financial year where the government’s borrowing programme is known and almost done with, and the banking indicators on credit and deposits growth are also almost final. Why then should we give importance to this policy? The answer is actually quite simple—we need to know how RBI sees the economy, which, quite interestingly, looks different when viewed from different angles. By this we mean that we all know that inflation is a concern but has been coming down. Besides, it is food inflation that has created a problem for us, something that RBI cannot actually address through its conventional tools of monetary policy. But, if RBI perseveres with rate hikes, which the market believes will be the right course, then it’s indicative that inflation is still the target and that it will continue to work on this number until the final objective of either 4% or 5% (which will be stated in its Annual Policy in May) is achieved. In fact, any rate hike will be indicative of further hikes during the year.
On the other hand, growth, though sanguine for most part of the year, poses a puzzle. While the number of 8.5% or in its vicinity will be accomplished, there is some concern on whether or not investment has slowed down on account of high interest rates. If one talks to corporates, there is definitely concern as investment plans have been deferred and only necessary investment has been undertaken. Now, if this tendency persists, there is a possibility of industry being drawn back with capacity utilisation having reached the optimal levels across sectors, in which case potential growth gets affected. The IIP numbers have brought little cheer last week and it is very likely that the target this year of 8.8% in manufacturing will not be achieved. This being the case, RBI has to think deeper before tossing the coin. Past behaviour of RBI indicates that it would not like to spook the market and hence will opt for an increase in rates by 25 bps, though strong economic rationale would probably suggest that a pause on March the 17th could be the best solution until a clearer picture emerges when the year ends.