RBI’s quarterly policy announcement would have normally continued with its policy stance over the past few months. But anticipation of a change or a pause had built up, given the government winning the trust vote, and inflation easing (from 11.91% to 11.89%, how does that constitute easing). The changed political and supposedly economic environment would give it legroom to pause interest rate hikes.
Well, nothing of the sort happened. In a sign that interest rates will have to go up further, the RBI has hiked the repo rate by 50 basis points to 9%. The cash reserve ratio has been hiked further by 25 basis points to 9% from Aug 30. The RBI is focused on bringing down inflation down to 7% by end-March 2009 and subsequently to 5%. It has kept 3% as its medium term inflation target. These are tough targets, though not new, and as recent experience has shown, the RBI is not sworn to these targets.
For industry, credit is going to be expensive and changes in interest rates have their own effect on currency, which pose their own set of problems then. The direction of interest rates is clearly headed up. Capital goods and construction sectors will face the heat more while all sectors will see higher interest costs. Rising interest rates will pose some problem for government borrowings too, but a government that has elections in sight is unlikely to be bothered by trifling things such as interest costs. The consumer will feel the pain more. Housing EMIs will rise so will that of other loans. The household budget will get squeezed. Consumer spending can be expected to slow down for that is what the RBI wants too. Demand has to slow down for prices to start falling, corporate numbers clearly show the inflationary effect on the top line. Despite a moderation in money supply and deposits’ growth, it is still above RBI’s expectations.