Inflation can't be tamed by raising interest rates: CII

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The Reserve Bank of India continued on a tightening mode - hiking key policy rates by 25 bps. The central bank raised its key lending rate, the repo rate, to 6.75% and its key borrowing rate, the reverse repo rate, to 5.75%. The CRR has been left unchanged. The RBI also raised its inflation forecast for March-end to 8% from 7%.

In an interview with CNBC-TV18, Hari Bhartia, President of CII & Shanto Ghosh from Deloitte India, discuss the implications of RBI's moves.

Below is the verbatim transcript of the interview. Also watch the accompanying video.

Q: This is the eighth hike that the Reserve Bank has taken since March 2010. At CII, do you believe that the rates hikes that the Reserve Bank has been undertaking have not really brought down inflation? Do you think that this problem cannot be solved by monetary policy action? Do you believe that the industrial growth will be severely or significantly impacted?

Bhartia: Yes, this is the eighth hike. At first, the inflation was affected by grain and then food and vegetables. Today, globally in the last six months, we have seen a higher commodity prices and very high oil prices. On the inflation front, the demand continues to be quite high.

Inflation cannot be controlled by increasing the interest rate. The other thing higher than the repo rates are the deposit rates, which is an indicator of very high interest rate. The deposit rates are in the range of 9 to 9.5%, which shows that the banks are short of money and that is not a good indication.

In such a tight situation, the investment part can get affected. As of now, the demand continues to be high and we need to build capacity. Right now, the investment rate looks good. But going forward, there could be pressures on investment.

On the budget at the fiscal side government said that the government borrowing will not be higher than what they has seen last year, so that is not a pressure. Overall, the high rate of interest could be a deterrent for further growth in investment and building capacity, which is desperately needed.

Q: It seems to be evident from what the Reserve Bank has articulated in its policy that a further hardening of rates will happen. Giving that scenario, how soon do you think will it start impacting investment activity? How soon will the industry find it difficult to fund investment activity? Do you think we are now closer to missing that 9% growth target that was been set out by the government?

Bhartia: Giving a timeline would not be possible as a lot depends on demand side. One of the things that government can certainly do is quicken up larger projects. If we clear the large projects, that will further spur some larger investments. It could be one way to increase investment, but we need to continue to watch the demand side.

Ultimately, the demand does not have an unlimited elasticity towards inflation. If inflation continues to be strong and interest rates are high, one would not know how demand will be perceived in the future.

The Japanese nuclear power mainly gets replaced with gas and not oil. Gas has been excess in the Middle East because US prices of gas has been quite low. US has been importing less gas.

To some extent, the gas prices may harden up a little bit. Gas supplies have been good. Even though refineries are shut, the oil prices may not go up that high because of Japan.

Q: The Reserve Bank of India finds itself in a bind. On one hand, its dealing with inflation as an enemy number one and the upside risk of inflation continues. The inflation target is revised upwards to 8% from the earlier 7%. On the other hand, it is acknowledging the fact that there are now emerging risks to growth. What is the Reserve Bank suppose to do in this situation?

Ghosh: That's a very pertinent point. The Reserve Bank does face a daunting task. If we look at the inflation number right now for February, it's at 8.3%. If we look at the wholesale price index (WPI) for the 11 months of this fiscal year, the wholesale price index inflation is at 5.57%.

There is a little bit of an upward bias in the inflation numbers. If the Reserve Bank does nothing, continues with its current policy and the trend of prices continue as they are, we will see an inflation number of 5-5.5% in a couple of months time.

Increasing the interest rates will be detrimental for our growth. Although the interest rate was along expected lines, this was a good time for the Reserve Bank to adopt a pause, wait and see approach because we are facing global uncertainty on our growth prospects.

Compromising the future growth potential and slowing that down will be far worse scenario. Inflation will taper down.

Q: The Reserve Bank has already been accused of being behind the curve. If it hadn't moved on this one perhaps, we would have had more in that camp, given the kind of inflation we are contending with?

Ghosh: It's always easy to look back and point fingers. If you look at the numbers, there is an upward bias in the inflation. The Reserve Bank has done a fine job. The interest rates were increased seven times in the past, which did not have a very perceptible impact.

Somewhere the monetary policy of changing interest rates and trying to affect inflation by changing interest rates is not working. The Reserve Bank is beginning to run out of options. People are beginning to question on the right monetary policy tool to target inflation.

Q: The Finance Ministry seems to be running out of options; you're saying that the Reserve Bank is running out of options because 8 hikes down the line it still hasn't been able to tame inflation. What are we dealing with here then?

Ghosh: Honestly, six months down the road we would not be talking about inflation. Inflation is on a downward trajectory and that will continue. There are bigger concerns that we should really be occupied with and that's directly impacting our growth prospects.

Right now, no one should do anything. Let's just wait and see. Unless there is a major shock which drives the oil prices to more than USD 150 a barrel or something major happens the current trajectory will automatically stabilize inflation.

Q: Do you think that the Reserve Bank should adopt a wait and watch policy and not hike rates at least not in May?

Bhartia: I completely agree with Ghosh. We should not look at increasing interest rates because I don't think that is going to control inflation. I fully agree that the inflation is going to come down now.

We cannot continue to see the increase in commodity prices as what we have seen in the last six months. Oil will stabilize. I don't think oil does not look like going up to USD 150. These are already very high prices. We should wait and watch.