Reining-in core inflationary pressure will be the acid test for the central bank

One question that has cropped up following the monetary policy review is whether there is a return to the days of high inflation, higher interest rates and modest economic growth reminiscent of UPA-II? The RBI, which hiked the key rates by 25 basis points for the first time since January 28, 2014, has however claimed to the contrary. Sticking to 7.4 per cent GDP growth and 4 per cent inflation — plus or minus two per cent — target during current fiscal presents a different economic story going forward. Yet, not many economists and multilateral organisations believe in the RBI narrative of resilience in the Indian economy while governor Urjit Patel has been emphatic on the possible achievements round the corner.

How does the economy under Narendra Modi compare with Manmohan Singh’s term in office? Even at 7.3 per cent as estimated by the World Bank, India will continue to be the fastest growing major emerging economy globally. India’s numero uno position will continue in 2019 and 2020 with a seven per cent plus GDP growth that would be way ahead of China.

The acid test for RBI would be in reining-in core inflationary pressure with consumer price inflation touching 5.3 per cent in May 2018, Indian basket crude prices that surged 12 per cent to $74 in mid-May from $66 per barrel in April this year.

Patel and his five-member monetary policy committee seem to have opted for a ‘pre-emptive’ strike on rising inflationary pressure by unanimously voting for a hike in repo and reverse repo rates by 25 basis points to 6.25 per cent and 6 per cent respectively. Though inflation reported in the last quarter was 4.9 per cent and by its own estimates, it would not cross 4.7 per cent in the next six months, RBI seems reasonably convinced that a hike in interest rates will not be a drag on the growth impulses. Several industry groups and economists agree with RBI’s assessment that GDP growth at 7.4 per cent does not need money policy boost. What could perhaps hurt the economy and GDP growth is a possible second hike in interest rates during this financial year, if crude prices continue to firm up.

The RBI governor has asserted that the central bank does not wish to slow down capital expenses or hit industrial output by enhancing the cost of debt funds. The central bank’s neutral stance also reflects flexibility going forward awaiting data inputs by July 31 when the MPC meets to reassess its policy options.

In the meantime, there is no denying the fact that auto, home and consumer loans for individuals and corporate debt for companies will become a bit more expensive. A big section of the industry believes that consumption demand may be hit owing to higher interest rates. But, RBI does not subscribe to this view.

More than the reduction in interest rates, bracketing housing loans as part of ‘priority sector lending’ is a significant move by the RBI governor Patel. This will give a big fillip to prime minister Narendra Modi’s campaign to provide houses to all. The second big point made by the RBI governor was on ‘valuation of state development loans’ that were credible instruments like central government debt paper. The RBI and the government may have few options to tide over the tipping point before Modi seeks a second term in April next year.