Need to Look Beyond Monetary Reforms: Inflation Induced Interest Hikes would Impact Exporters

The Reserve Bank of India has sharply hiked key rates by 50 basis points in the 11th such exercise since January 2010 to tame inflation, setting the stage for commercial banks to raise their interest charged on personal and corporate loans. The central bank has revised its repo rate to 8 percent from 7.5 percent and reverse repurchase rate, or interest paid on short-term lending, raised to 7 percent from 6.5 percent. The rate hikes were affected by Reserve Bank of India (RBI) Governor D. Subbarao during the first quarterly review of the apex bank's monetary policy for this fiscal year.

"Notwithstanding signs of moderation, inflationary pressures are clearly very strong," Subbarao said, addressing the chief executives of commercial banks after the policy update. "Keeping in view the domestic demand-supply balance, the global trends in commodity prices and the likely demand scenario, the baseline projection for wholesale inflation for March 2012 is revised upward from 6 percent with an upside bias."

In the policy update, the reserve ratios -which call for the quantum of money against deposits banks have to keep as liquid assets -stood unchanged at 6 percent in the case of cash reserve ratio and 24 percent in the case of statutory liquidity ratio. Briefly, the new rates would work out to:

  • Repurchase rate, or short-term lending rate, hiked to 8 percent from 7.5 percent.
  • Reverse repurchase rate, or short-term borrowing rate, hiked to 7 percent from 6.5 percent.
  • Cash reserve ratio retained at 6 percent.
  • Statutory liquidity ration retained at 24 percent.
  • Bank rate untouched at 6 percent.
  • Inflation expected to remain elevated for few more months.
  • Moderation in inflation seen toward latter part of year.
  • Projection on annual inflation for year-end at 7 percent, against 9.4 percent now.
  • Projection on growth left unchanged at 8 percent for current fiscal.
  • Intention to maintain interest rate environment that moderates inflation.
  • Policy also tuned to manage risk of falling growth.
  • Measures to manage liquidity without undue stress on financial system.
  • Outlook for global crude oil prices uncertain in the near future.
  • High global commodity prices may also exert pressure on domestic inflation.
  • High global crude prices, domestic fuel subsidies will impact inflation.
  • This year's monsoon may impact yields of grains, pulses, oilseeds and cotton.
  • Inadequate supplies may keep prices of eggs, meat, fish, milk and pulses high.
  • Government's fiscal deficit target of 4.6 percent now a major challenge.
  • Real estate markets have remained firm.
  • Next mid-quarter review of monetary policy Sep 16.
  • Second quarter review of monetary policy Oct 25.

The Reserve Bank of India's (RBI) aggressive monetary tightening measures would help bring down inflation to a comfortable level of six to seven percent by the end of this year from the current near double-digit, Finance Minister Pranab Mukherjee said. Reacting to the RBI's move, Mukherjee said through the rate hike the Central bank had sought to give a "strong signal to further moderate inflation and check inflationary expectations". "With this policy adjustment, we will be able to get back to a more comfortable inflation situation that takes us to the year end inflation level of six to seven percent," Finance Minister said in a statement. On impacts of rate hike on the economic growth, Mukherjee said despite some moderation in the recent months he was hopeful of maintaining the growth momentum.

Notwithstanding some slowdown of GDP growth in the first quarter of 2011-12, as reflected in the some indicators including the IIP and moderation in the growth of interest-sensitive sectors, the overall GDP growth for 2011-12 so far is in line with the momentum attained in 2010-11, he said.

But this has not gone down well with the exporters. Rakesh Vaid, President, Garments Exporters Association has expressed disappointment on the RBI decision to increase the key interest rate by 50 basis points. With this increase in Repo rate the interest rate for exporters will go up by more than 70 per cent within one year only. In fact RBI had been continuously increasing the Repo Rate resulting in persistent and significant hike in interest rate. The financial problems of exporters were further aggravated because of the withdrawal of 2 per cent interest rate subvention which has not yet been restored. Higher interest rate will make our exporters less competitive in the international market. The cost of export credit along with continuous hike of wages and raw materials cost will further reduce the competitive strength of garment exporters.

While the Government may have its own reasons to increase the credit rates, but it needs to be remembered that the Central bank, before the present hike, had spiked its key rates a record ten times since March 2010, resulting in higher short-term lending (repo) and reverse repo or borrowing rates by a massive 275 basis points. But still the desired result - inflation at a comfort zone - is hardly achieved.

In response to the monetary tightening commercial banks have continued raising their rates, thereby making loans costlier for the industry. As a result, credit off-take and industrial output growth both have slowed down, with the latter falling to 5.6 percent in May, mainly due to manufacturing downfall and slump in capital goods output, so much so that the new figures have forced the government to lower its economic growth forecast to 8.6 percent for the current fiscal from about 9 percent earlier. This has now further been reduced to 8.2 percent.

For exporters, the debt crisis in the EU region, India's largest export market, is another woe, which could certainly upset the recovery in the exports that have grown in high double digits over the last few months. Also, the greater than anticipated slowdown in the US economic activities, and the renewed downside risks in the world economy all signal darker prospects for the export sector.

So, both the external and internal factors, like dark clouds, have already started hanging over the economy, the industry, the exporters, and the small and medium scale enterprise sector - for all, and the laksh move by the RBI would certainly have bad effects in terms of growth prospects, and even some worse outcomes can be anticipated if inflation again refuses to be tamed down.

Originally Published in The Stitch Time, Aug-2011