Column : This is no time for rate hike

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: RBI governor D Subbarao has hinted at a rate increase sooner than that in developed countries. At the same time the Reserve Bank of Australia raised interest rates. It is the first G20 country to have raised rates. The question this raises is whether RBI will raise interest rates soon?

What are the factors that should shape RBI’s decision on interest rates?

The most important factor is growth. Is growth back on track? There are three important aspects to this question. First, while 6-6.5% GDP growth might look high in comparison with growth in the US, UK and Europe, it is below India’s decadal average. The Indian economy, as in the case of other emerging economies, does not witness business cycles around a zero percent growth rate. As a developing country, growth rates here are much higher and fluctuate around a long-term trend. While the issue of calculating this trend is difficult, and there is plenty of academic debate on it, one simple way of looking at it is to think of the trend as a decadal average. This, looking back, is roughly 7-7.25% for India. Further, if we think of this as a long term potential growth rate for India, then as long as we are growing below this growth rate, there is space to expand, and grow faster, and, when we are above this potential growth rate, policy makers need to watch out for signs of overheating and of inflationary expectations.

The second aspect that matters for growth in India is global conditions. While most people agree that the worst is over, the question of whether the recovery is U-shaped or W-shaped is still not on. It is not entirely clear that when the effect of fiscal stimuli of the G20 countries wears off, growth will contine, and if so at what pace. Until this unfolds, there will remain a significant amount of uncertainty in the world. Indian business cycles are highly sychronised with global, and especially, US business cycles. If there is a W shaped recovery in the US, we may find that the growth we have witnessed in the last two quarters may seen a downturn again. To take a concrete example, export growth of automobiles recovered thanks to the support offered by European and US governments. Will this growth be sustained after the concessions end? The answer is that it is too soon to say.