'RBI stance may slow growth'

Tuesday's announcement by the Reserve Bank of India that it would tighten liquidity and re-emphasize its anti-inflationary monetary policy stance constitute monetary normalisation and could come at the cost of slower short-term economic growth, according to Moody's Investors Service.

"From a credit standpoint, the preservation of India's macro-economic stability remains in a critical phase, and Tuesday's moves are consistent with that," said Moody's vice-president - senior analyst Aninda Mitra.

"In an atmosphere of still-strong underlying growth, a prolonged tightening stance goes to show that one or two benign price signals are not enough to effect a short-term change in the course of policy."

In Moody's view, he said, it is not usually enough for policymakers to simply manage short-term demand without credibly addressing longer-term capacity problems, especially in high-growth potential economies.

"Nor is it typically feasible for the private sector to somehow step into the structural void and bear the financial brunt of capacity building," said Mitra.

As a result, he said, Moody's believes that a tightening bias in the overall monetary framework could remain in place, until the government is further able to reduce its own debt burden, which currently precludes better resource usage in more productive areas, or officials can establish a more effective enabling role for the private sector or foreign participants in the capacity-building process.

"Current trends indicate that both fiscal consolidation and more private domestic and foreign participation in capacity building are indeed progressing," said Mitra.

But Moody's believes the gestation period for such fiscal and supply-side responses could take considerably longer to be felt by the real economy and may not neatly dovetail with short-term demand management policies and price expectations.

"This is also evident from the RBI's July 31 hike in the cash reserve ratio and what some commentators have called a 'hawkish bias' in the overall credit policy announcement," said Mitra.

He said, the former refocused attention on the inflationary risks of prolonged balanced of payments-driven unsterilised increases in the monetary base, and the latter emphasized need for more visible evidence of demand-side cooling from the lagged effects of past tightening, as well as continuing vigilance against the risks of further supply-side price pressures.