RBI’s aims is to bring down Inflation even at cost of economic growth

India (ET): The central bank did it again. After injecting a sense of stability with calibrated hikes over the past year, there have been, surprisingly, two more 50-basis-points (bps) hikes since April 2011.

The Reserve Bank of India (RBI) has also made clear that it now wants to reduce growth to address galloping inflation. We don’t agree - but these are grey areas at best, and there are very strong arguments on either side.

The wholesale price index (WPI) is expected to touch 10% levels this month, trending slowly towards 6.7% by March 2012 if we are lucky. Since the message has gone home quite clearly this time round and manufactured products inflation is expected to move to 5% levels only by April, additional 100-bps rate hikes seem on the cards by March.

What does this tight policy actually mean for the economy? As we have said earlier, the rate hike will do little to stem inflation, the pressure is coming in from primary inputs, food and fuel.

The RBI knows this, which is why it has kept rate hikes moderate so far.

 With supply constraints not easing, thanks in large part to government policy, the strategy is now to hit on the demand side through high rates, effectively dampening growth, and through that, hope that inflation eases.

 The problem with this kind of strategy is that the long-term impact is much more serious than what will happen in the short term.

   So far, while investment rates have already fallen during January-March, current data shows that apart from auto sales and IIP numbers, all other indicators appear fairly impervious to the rate hikes.

 PMI manufacturing is lower, but service sector PMI is still high, exports are up, non-oil imports are up, and growth in non-food credit has fallen just marginally.

    A large part of the economy, therefore, seems to be taking the rate hikes in its stride. Also, tax refunds of more than 46,000 crore for the last quarter will definitely add to the demand equation, and to the fiscal risks with higher borrowings.

    So, the question on the top of our minds is what if the growth slowdown does not materialise as the RBI desires? And how much longer will the foot be on the pedal? The central bank appears quite emphatic about pressing ahead till inflation in manufactured products begins to show signs of moving steadily downwards to the long-term average of 4%, which can be seen as a target.

      So, we hope the slowdown does show up sufficiently in the data soon, because the alternative will be very painful for the long term. For the time being, however, apart from some minor indications from the automobile and real estate sectors, the only indication is of an investment slowdown, not a growth slowdown. In other words, one thing that is certain is that 8%-plus growth would be difficult to achieve from next year due to the dramatic fall in investment growth.