In what seems to be a mechanism to fight the outflow of money, Indonesia has raised interest rates by 0.5%. The new rate is now 7%.
Brazil on the other hand is fighting inflation and has raised rates to 9%. They even say they are likely to raise to 9.75% by the end of the year. And inflation in Brazil is 6.15% against their target of 6.5%.
India’s inflation rate (CPI) is nearly 10%. WPI is around 5% but has risen in July, and due to the currency depreciation, is likely to rise further in September, past the 5% mark.
The new RBI governor has his first macro-economic policy statement in the end of October, around the time of Diwali. Will this Diwali bring us a rise in interest rates? Or will we act before that, to stem the flow of dollars out?
Remember that earlier, our tweaking interest rates was feared to create an impact on the dollar exchange rate. That didn’t make sense because we didn’t allow foreign investors to invest easily in our government debt or hedge out the currency impact. Given that some of those restrictions have been eased now (though many remain) and hedging is possible, it is much more likely that a change in rates will help ease exchange rate issues.
But alongside we need to give foreign residents more freedom – buy debt “on tap” rather than get FII limits in auctions, allow individuals (not just NRIs) to buy debt through mutual funds and hedge and so on.
Raising interest rates will signal a completely different concept from Operation Knicker-Twist, which involves raising short term rates but keeping long term rates low, and which I believe will fail. But at this time, we have to actually signal raising rates – not to attract foreign capital, but to control inflation.