The Indian central bank is signalling what we expect it to signal: cool down things a bit in the inflation-wracked Indian economy. But is it really the right diagnosis? It has hiked the CRR by 50 basis points to 8%?the increase will happen in two stages over the next two weeks?to soak up liquidity and contain inflationary expectations. Let?s get one statistic in: RBI has steadily raised CRR 11 times since the second half of 2004, but this is first time that the CRR has been raised after GDP growth has slowed down, as it has in the second and third quarters of 2007-08. This indicates RBI?s mindset. Now let?s ask how the liquidity mop up will impact cost and availability of credit and growth. And also ask whether some policy stands are not turning interest rate hikes inevitable, making a nuanced response all but impossible.
The first question is especially relevant because growth in non-food credit by scheduled commercial banks in the last fiscal year was 22.3%, much below the 24-25% range targeted in recent years. Non-food credit declined by more than what authorities wanted. So, why isn?t this being factored in when policies are made on how much credit should be available? Is it that credit growth, even if moderate by official targets, is far in excess of the economy?s genuine needs? Compare India with other major emerging economies. Credit growth here has been much less rapid than in the emerging world. India?s share of private credit in GDP went up by 2 percentage points in 2007. In China, Brazil and Russia, the figure is 2.6, 5.1 and 7.1 percentage points, respectively. Let?s acknowledge that there?s enough circumstantial evidence that India may be suffering from monetarist orthodoxy when it comes to calculating optimum credit availability. Let?s also admit that there?s logic in this excess, which brings us to the second question. If RBI is not going to allow the rupee to appreciate, which is an excellent anti-inflation tool, and since interest rate differentials between India and capital-rich countries are large and growing larger, capital inflows will swell, and they will need to be neutralised to maintain the rupee-dollar peg. That means more liquidity sloshing about the system. And that, in turn, means more CRR hikes, by the look of things. This is how a high interest rate policy becomes rigid. That doesn?t do either RBI?s reputation as a policy manager or the economy any good.
