Govt Waves the Stop Sign as RBI Readies to Flag Another Rate Hike

High rates harming growth, says Kaushik Basu

    The central bank's monetary tightening has harmed growth instead of taming inflation, the country's chief economic advisor has said, sending an unequivocal signal three days before a crucial RBI rate-setting meeting that the government wants no more hikes. 

This rare display of the government's discomfort with the monetary strategy being followed by the central bank signals a public breaking of ranks between the two navigators of the economy on how best to steer it from here. 
As the RBI prepares for its mid-quarter monetary policy review on Friday, in which it is widely expected to raise rates by another 25 basis points, Kaushik Basu acknowledged the task before the central bank was not an easy one. "However, what RBI will have to consider is that interest rate tightening has not had the desired impact on inflation that we were hoping for. It is having an impact on growth," he told ET NOW in an interview. 
His intervention marks a hardening in tone from the finance ministry, which has so far gone along with the RBI even though it may not have agreed with the central bank's stance. Finance Minister Pranab Mukherjee had earlier this month expressed hope that the RBI would desist from raising rates further, saying "the existing monetary policy of reining in inflation may not have to be extended". The RBI has already raised key rates 11 times and by a cumulative 325 basis points since March last year. These have not managed to completely tame inflation, which remains too high for the central bank's comfort. July inflation was at 9.22% and estimates for headline inflation remain as high as 9.7% for August. The government will release inflation numbers for August on Wednesday. 
But the rate tightening is helping put the brakes on economic activity. Industrial production growth has eased, falling to 3.3% in July from 6.6% in June. Industry has been complaining as its cost of credit has been rising, and so are banks, which fear rising rates will lead to an increase in bad loans. GDP growth forecasts for the year to March 2012, first estimated at around 9%, have been scaled down by most economists to around 8%. 
Despite all this, most expect the RBI to continue to increase interest rates until it is convinced that inflation has been tamed. But Basu said it was time to change tack, suggesting that higher interest rates carried with them the danger of attracting capital flows of money borrowed at cheap rates overseas, which could also fuel inflation. Time to Bend Conventional Rules 
"Conventional monetary tools may not curb inflation. Interest rates have not had the desired impact," he said, adding that there was a case for the RBI to consider an "unconventional move". "Once you move away from that instrument, there are other instruments, which are fiscal policy and other monetary moves which can handle inflation." 
Basu, an economics professor who has taught at several US universities before returning to New Delhi to take up his present job, said the monetary authorities' failure to curb inflation despite raising rates pointed to the changing structure of the global economy. "The RBI should indeed take a serious look at the situation worldwide and the experimental moves undertaken by Turkey and Brazil," he said, referring to the decision of the two countries to cut interest rates in the face of high inflation. "In the Turkish case, they took the view that with the carry trade and other problems, they will have to lower interest rates. As a result, Turkey's inflation, which was above 10% in April last year, is now down to 6.2% in July this year. Thus, contrary to expectation, the lowering of interest rates has not made inflation worse," Basu said. In Brazil too, the central bank late last month cut its benchmark rate by half-a-percentage point to 12%, reversing course after a year of rate hikes. 
As for India, Basu said he expected inflation to hover around 10% until the year-end and decline from December. "Thereafter, non-food inflation will fall off faster than food inflation. Food inflation will prove to be difficult for us from January. Food inflation will be a bigger concern during February-March," he said. 
Basu also said he expected GDP growth for the current fiscal year to be 8-8.1%, with exports and FDI flows mitigating "below par" performance in manufacturing and industry.