The RBI did it again, after putting in a sense of stability with calibrated hikes over the past year, there have now been two 50 bps hikes as surprises since April. It has also made very clear that it now wants to reduce growth to address the inflation problem. We don?t agree, but these are grey areas at best, and there are very strong arguments on either side.

On the one hand the WPI is expected to touch 10% levels this month, trending slowly towards 6.7% by March if we are lucky. Since the message has gone home quite clearly this time round and since manufactured products inflation is expected to move to 5% levels only by April, another 100 bps of rate hikes seems to be on the cards by March.

What does this tight policy actually mean for the economy? We have said before, the rate hike will do little to stem inflation, the pressures are 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 dampen 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 in Jan-March, current data show 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 still high, exports are up, non-oil imports are up, 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 Rs. 46,000 crores for the last quarter will definitely add to the demand equation, and to the fiscal risks with higher borrowings.

The question that is on top of our mind 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 RBI appears quite emphatic about pressing 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. We do hope that the slowdown does show up sufficiently in the data very soon, because the alternative will be very painful for the long term. For the time being however, apart from some minor indications from 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%+ growth would be difficult to achieve next year onwards due to the dramatic fall in investment growth.

And then there are the added risks lurking on the global front, if these risks materialise, the tight policy in India can hurt much more than intended. What is the alternative though? It is interesting that the RBI has now gone all out on the government, saying what we have been saying for a long time ? the bank has to raise rates and will have to continue to do so, essentially because of lack of support from the government. The growth momentum in the economy is very strong, giving substantial kick to demand; the frustration of the bank bearing the sole responsibility for inflation is now showing up as government inaction gets magnified.

It?s all fine for the RBI to suggest that the government shift from revenue to capital expenditure and build in the requisite infrastructure? the list is long and well known. There is barely any action on the horizon here. So unfortunately, the way things are playing out, what will happen is that the economy will take the hit where it hurts the most, its long term growth potential - a sad twist to the India story.