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How will RBI do a balancing act?

Jul 27, 2009

The next few quarters are likely to be a tough period for the Reserve Bank of India (RBI) when it comes to maintaining a balance in its monetary policy. With India's fiscal deficit widening to 6.8% of gross domestic product (GDP) and government borrowings likely to rise to Rs 4.5 trillion, the central bank is in for a challenge on how to gravitate within its interest rate spectrum. As you know, maintain the right level of interest rates to propel growth and at the same time keep inflation under control is the prerogative of the RBI. And how successful will it be in doing this balancing act remains to be seen.

Most economists expect the RBI to maintain a status quo on interest rates (and not increase rates) given that we still remain unclear about the sustainability of an economic recovery. Further, factors such as poor monsoons and slow credit growth cannot be ignored.

During the month of June, the monsoon deficit figure stood as high as a 48%, the lowest in nearly 15 years. As for data related to the credit growth, the same is believed to have come down to 16% YoY in the month of June, which is again the slowest in a few years.

Proponents of a cut in interest rates further cite the declining inflation as a major reason. As a matter of fact, the wholesale price index (WPI) inflation rate has been in the negative zone for about six weeks and as per the latest available data, it stands at a negative 1.17% (or deflation). The central bank is thus expected by some to cut rates further to help revive demand and bring the country out of deflation, which is considered even worse than inflation.

So, how will RBI do a balancing act? We will not hazard a guess here. There are, in fact, too many variable factors that the bank needs to take into account before announcing its next policy action.

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