It would be better to wait and watch at this time

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: A number of issues need to be considered to decide on the policy stance. Let’s consider these one by one. Wholesale price inflation is just below the RBI’s upper limit of 5.5%, but shows signs of falling. The primary impetus has come from primary goods and fuel, which are regarded as volatile non-core components, not amenable to monetary tightening. Of course, the prices of these two categories are not volatile in India, being subject to considerable administrative and political interference—domestic oil prices rise but rarely fall. But the interventions are outside the RBI’s purview. Since world oil prices have softened, the pressures for a rise in domestic prices and inflationary expectations on this count are relieved.

The current account deficit has widened but remains manageable, given bountiful reserves and healthy export growth of 23%. Output and broad money growth have both exceeded the RBI’s projections. Growth in bank credit to the commercial sector has fallen below its earlier 30-plus rate of growth, but remains robust. A steep, sudden rise in credit makes the financial sector vulnerable, but our credit GDP ratio is low compared to other countries. It can be raised, but in a sustainable way. Good corporate results have driven up stock market indices again. The rupee is showing two-way movement. Markets seem robust, having taken fluctuations in their stride.

Is the economy overheating? Does a more than 9% rate of growth exceed the current potential, requiring a counter-cyclical tightening of interest rates? When there is uncertainty regarding potential output, it is not helpful to follow quantitative targets on money or credit. It is better to infer the existence of excess demand from outcomes such as inflation. It is also unwise to make large changes—marginal adjustments affect market expectations and deliver results, while taking time to learn.

An emerging market has to be very careful about potential volatility in capital flows. Therefore, a good rule of thumb is to respect arbitrage, keeping domestic interest rates aligned to international rates. The US Fed seems to have come to the end of its rate raising cycle, having kept the Federal Fund Rate unchanged at 5.25% in the last three meetings. Our comparative call money rates are in the range of 5.7-6.75%, while core inflation rates are similar. We are close, but the appreciating rupee and falling risk premiums give us some leeway.