Indian’s Central Bank Succeeds in Delicate Juggling Act

Wednesday, 20 Jul 2011 09:15 AM

By Ashish Advani

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This is my second week in India and I am in Mumbai this week.

This is where I was born and no matter how long I have stayed away, I still consider this town as home.

It has changed dramatically and traffic is horrendous. Adding to the woes is the heavy monsoon rains. It has been raining hard every day that I have been here. And yet, I can hear the sound of business, money and industry above the din. This city is very akin to New York.

Built on five islands, this city is the thriving and buzzing commercial capital of India.

Last week on Wednesday, Mumbai witnessed another terrorist attack with bombs being exploded in three crowded areas of trade. This is the fifth ghastly dastardly attack on Mumbai in the past 10 years. And yet, like New York City after the 9/11 attacks, the city winces and then charges ahead.

In fact, some of the media accuses the citizens of Mumbai as too callous and accepting terrorism as a way of life here. While I believe there is some truth in that accusation, the folks here are tired of being treated as a punching bag and unless some serious action is taken, some businesses will start leaving Mumbai for nearby towns.

Once again, like last week, I have been in long discussions with bankers and stock brokers in Mumbai. And the message from here is very optimistic and yet a slight concern.

There is a very interesting tug-of-war occurring between the Reserve Bank of India (RBI) and Dalal Street (the equivalent of Wall Street in Mumbai). Unlike the United States, the RBI hasn’t sold its soul to the vagrancies of the stock markets. The RBI is, in my opinion, one of the most prudent central banks in the world. It takes the right steps at almost the right times to regulate the economy.

The RBI has raised rates for the past year and half to cool the economy. It has raised rates by 425 basis points (i.e. 4.25 percent) to cool off the Indian business activities as well as dampen inflationary pressures. While it has succeeded with the first, it has partially succeeded with the inflation targeting. Yet it is now time that the RBI shift its direction from a tightening stance to that of a wait-and-see approach.

The businesses are really groaning under the borrowing rates, which are well into double digits. And this has certainly slowed the business activities significantly. So the focus shouldn’t be singularly focused on inflation alone, but achieving the delicate balance between controlling inflation and allowing businesses to grow.

The slowdown in businesses is clearly apparent in the economic data now.

The last month’s industrial production rates, manufacturing growth rates as well as slowing consumption rates are all pointing to a serious slowdown in activities in the business activities. One cannot attribute this slowdown to that of an inventory burn as the consumption patterns are definitely slowing.

What is pretty clear (at least to me) is that the following need to happen to ensure a soft landing and a sustaining growth pattern for India:

• The monsoon needs to end at normal levels. Currently monsoon is running at a 2 percent deficit. If the monsoons in Mumbai are any indicator, we will see a normal monsoon by end of August.

• RBI will most likely hike rates again by 25 basis points next week. But it needs to clearly indicate that it is taking is foot off the pedal and get into a neutral stance. Maybe one more after next week, but certainly no more than that.

• The oil prices (global) need to stay steady at current levels if not decline by 5 percent to 10 percent.

If the above comes true, we will see a stellar year again from India. We will see a 7.8 percent to 8.0 percent GDP growth. We will also see a 10 percent to 15 percent rise in the stock prices starting later September through December. We may see a slight weakening of the Indian rupee, but in the overall scheme of things, that will be a help to the export related industries.

I am extremely bullish on India and I have full faith on the RBI to do the right thing at the right time to guide the economy to a long term sustained path of growth.

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