RBI must remain vigilant, cautious

The Reserve Bank of India’s decision last week to go in for a second interest rate hike of 25 basis points in two months, taking it to 6.5%, underlines its concern over the inflationary potential that has developed in the economy. Consumer price inflation reached 5% in June, thus remaining above the medium-term target of 4% for eight months in a row. This has a couple of not-so-positive implications. One, if the inflationary momentum does not die down, further rate hikes will be administered. The central bank’s neutral stance in the matter indicates that it is keeping its fingers crossed. If further rate hikes do come, that will unambiguously make bank credit costlier at a time when business has been experiencing a shortage of credit because of the banks’ own problems. If such a situation were to emerge, the prospects of growth picking up again, which RBI sees signs of, after the setbacks caused by demonetisation and introduction of GST, will be nipped in the bud.

The inflationary potential is being stoked by two factors, one already there and the other foreseen with some trepidation. The most serious boost has been administered by the sharp rise in minimum support prices for cultivators, which the government has announced for the current kharif season. On top of this, there is a clear likelihood that the fiscal balance will be under strain as elections get closer because of the compulsion that the government will have to face in giving away some freebies.

If the domestic pressures on the inflationary front are worrisome, albeit mildly right now, there is little good news to be had from the international scene. Oil prices are steady right now, after having done the damage in the recent past, but what is troubling is that there is no certainty that they will not be upward bound in the next few months. Even without a further spurt in oil prices, the global trade scene gives no cause for cheer, what with US President Donald Trump initiating tariff wars on multiple fronts. This will not make it any easier for India to sustain an improvement in export performance, which is sorely needed because of serious underperformance in the past. It is necessary to emphasise that despite the negative factors outlined above, economic prospects remain bright on the balance, driven in part by strong corporate earnings. This is sustaining a positive trend in stock prices, which can be expected to do their bit to boost sentiments for investment. Thus, while there is no immediate cause for concern, there is every reason to remain vigilant and cautious.

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RBI must remain vigilant, cautious

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