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Reserve bank of India is sandwiched between ensuring growth rate for India and controlling the inflation monster. The Reserve Bank of India has hiked policy rates by 325 basis points since March 2010, following which most banks have hiked lending rates by up to 250 basis points making loans dearer for borrowers.
The central bank, which meets next Tuesday to review its policy stance, is expected to raise rates by another 25 basis points. Base rate hike means that borrowing costs will go up as banks will lend at higher rates. When borrowing slows down means that industry growth will slow down. Thus it is a vicious cycle and RBI has to balance the cut. The above screen shot explains the impact of interest rate hike and interest rate cut.
Reserve bank of India has to tread the path of credit squeeze bit more cautiously as an average Indian is hit hard by inflation on two counts. One is by eating into savings, and the second is by indirectly weakening the balance sheets of institutions holding government debt. Moreover, because India does not have capital account convertibility, the saver cannot take his money out of the country. What this means is that although both the scenarios (notably higher GDP growth and lower inflation) are important for the well being of the Indian economy, when it comes to choosing between the two, inflation control should take precedence. After all, lower rate of savings will automatically make Indians wary of going on a spending spree and for India Inc, which is relying on the Indian consumption story among other things, such a development will only make things more difficult for business.
