## Tuesday, July 04, 2006

### Outlook for next RBI rate hike

Andy Mukherjee says a next RBI rate hike is very likely.

An article in the Business Standard "Smart Investor" supplement from yesterday, followed up by an edit today, mulls over similar themes.

One aspect that requires care in reasoning is the long lags between shocks to interest rates and their consequences for prices. Inflation may have a here-and-now urgency in the Indian political discourse. But rate hikes today will really help inflation closer to the next general elections :-)

Sometimes, there is a conflict between the needs of the domestic business cycle as opposed to the needs of the pegged exchange rate. Right now both are flashing positive, so there really isn't a conflict between the two. Even though RBI does not have monetary policy autonomy, what it does in order to hang on to a pegged exchange rate is roughly okay when compared with the needs of domestic inflation.

1. Ajay,

Yes, having a (pseudo)peg to USD makes RBIs policies a bit wayward.

What will happen to Equities market when RBI hikes rates this month ? (also assuming Japan will hike the rates) ? Won't the liquidity "downturn" stop the music for Equities ?

2. Hi Sir,

In a scenario where inflation is rising due to supply constraints, is their a need to raise interest rates?

Isnt it like saying that if a country is faced with a drought, which results in an increase in prices and therefore a higher inflation, it should hike interest rates?

--
Ravi.

3. Agriculture is already down to 20% of GDP and steadily trending down. The vulnerability of overall agriculture GDP to the monsoon is going down (think vegetables / milk / meat production - the high value stuff dominates output). Economy-wide supply shocks don't happen much in a modern market economy.

And if a bad monsoon drives up prices then Yes, I think there's a good case for tight monetary policy to anchor prices and price expectations. The benefits from anchoring future expectations about inflation are simply enormous.

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