|So it?s official, the Indian economy is
doing very well, thank you. The RBI and the Finance Ministry can pat themselves
on the back for having got so far. But the party spoilers this time are the bad
guys from the West.
As anticipated in our last newsletter, the fall in the rupee in August was
shortlived, the US rate cut sent markets in a tizzy. But when America sneezed,
central bankers around the world reached for their hankies. For the RBI,
cutting rates would be a signal, unleashing more euphoria in a market that is
already high on ecstasy. Lending rates are already dropping in the competitive
loan market; banks need to survive. We therefore do not foresee a rate cut,
though the CRR may be raised to check liquidity, if rupee management remains a
concern. Keep in mind that the RBI is geared to ?respond promptly? to evolving
situations - the October review date is not sacrosanct for a decision, which
does make for increased uncertainty.
The global financial system is in a mess and this includes big banks like
Merrill Lynch, Morgan Stanley, Citigroup?you would have thought they should
have known better how to manage money. And then there?s credit card debt on the
rise ? what Fortune magazine calls a 915 billion dollar bomb in consumer
wallets. You have a housing market problem and a potential consumer spend
problem in the US. Result? A very imminent recession has led to cuts in the
interest rate by the Fed.
But other countries can?t follow suit yet. The same compulsion that kept the RBI
from dropping rates here is showing up around the world ? that is, its expected
impact in increasing inflation. Our inflation numbers look benign in part
because fuel prices haven?t been allowed to go up, the underlying pressure
won?t go away though. China raised fuel prices by 10 percent, the first time in
17 months. The European Central Bank is faced with tackling surging inflation,
thanks to rising energy prices.
Where do we go from here? The Indian economy will continue to do well as the
growth momentum is strong, but the economy is highly integrated now and
international news is not good. At some point the negative international
impulse will combine with underlying inflationary pressures, impact of high
rupee value, and high interest rates. The large rises now will be followed by a
large fall in the stock market ? when that will happen, we have no clue.
The credit policy has added an extra goal to monetary policy now - to be ready
with all possible measures to respond to the unusual heightened global
uncertainties and unusual policy responses from regulators abroad. This could
mean curbs on foreign money inflows, but what would be more effective in the
long run would be to see measures to direct funds towards infrastructure needs
in the country. This of course requires more deregulation by the government.
But letting go is tough so it?s difficult to expect much change here.