Pride seems to have gotten in the way of sound policy-making in India, where a headstrong RBI refuses to concede defeat in its quest to bring down equally stubborn inflation.
Financial market participants have watched, initially with sympathy and then dismay, as the Reserve Bank of India raised rates 12 times in 18 months, causing growth to slump while inducing no discernible impact on inflationary pressures.
The market is braced for RBI Governor Duvvuri Subbarao to announce a 13th rate rise on Tuesday. Ideally, he instead would hold rates steady and allow time for an inevitable downward drift in price pressures as growth slows further.
"Enough damage has been done," says Sanjay Mathur, chief economist for Asia ex-Japan at the Royal Bank of Scotland. "But they are so deep in the quick-sand that they are finding it hard to reverse course now and say food prices are not our problem."
Like most other economists, Mathur feels sorry for Subbarao. Hapless or not, the governor and his board have had precious little help from the government in tackling pressure points, such as supply bottlenecks in food.
On the contrary, much of today's double-digit rise in food prices can be blamed squarely on the Congress government's pet employment program, where rural households across the country are assured of a temporary job and a wage that is linked to inflation. That unremitting cycle of higher wages spurring higher inflation will not be broken by merely raising rates.
Doggedly Persist
Should the central bank then doggedly persist with nonstop rate rises that appear to have little impact on inflation?
The finance ministry thinks it should. Private economists are irked that the RBI has become the government's convenient scapegoat, providing politicians a distraction from their flawed fiscal policy.
"I think that the last move was excessive and another would be bad policy," said Huw McKay, Asia economist at Westpac.
Another rate rise wouldn't just be bad policy. It would isolate India even further in a global policy landscape that has every other central bank turning dovish in the face of a euro-zone crisis and recessionary signals in the developed world.
It would also amplify the criticism, further harming not just the central bank's credibility but also the funding woes of an already fraught industrial sector.
Undoubtedly, there still are proponents of further monetary tightening in India, several of whom argue that it is imperative that inflationary expectations be dislodged for inflation to escape a self-fulfilling momentum. And monetary policy is the best tool for that.
The 3.5 percentage point rise in policy rates since March 2010 has had some desired outcomes -- money supply growth has fallen, a bubble-like property sector has cooled, inflation is high but not rising and loan growth is much lower than it was at the beginning of the year.
Big Blow To Growth
Despite being forewarned that the central bank was prepared to sacrifice some growth until inflation came under control, economists, businesses and consumers alike have been shocked at how big a blow policy has dealt to sentiment and demand.
Industrial output growth has slowed to low single-digits, banks are in distress as loan demand stagnates while their cost of funds soars as depositors shift money from cash to time-deposits paying a whopping 10 per cent. The investment that the economy needs to preserve its still reasonable overall growth has nearly stalled.
The policy approach was right initially, say analysts, but not the way it was communicated. Quite possibly, analysts suspect, the RBI stumbled because of the conflicting demands of its rather wide mandate, encompassing growth, price stability and the efficiency of the financial system.
To CLSA economist Rajeev Malik, the RBI's credibility was hit during the long tightening process by the way it "actually revised up its inflation forecast despite more interest rate rises."
Another drawing flak is the RBI's medium-term inflation target of 4 to 5 per cent. The wholesale price inflation measure used by the central bank has exceeded 5 per cent every month since early 2006.
Likewise, it seems stuck in a time warp with its forecast of 8-per cent-plus economic growth. Malik fears India is on the cusp of sub-seven per cent growth, almost a hard landing for the world's second-most populous nation.
"Admittedly, there are several things that are not in RBI's control. But surely more effective guidance is not one of them," Malik wrote recently.
Conditioning The Markets
Things could have been done differently. For instance, by raising rates at every 6-weekly meeting this year, the RBI has conditioned the markets into anticipating one each time, and into interpreting any pause as a policy shift. It has displayed impatience in expecting rate rises to traverse through a $1.6 trillion economy in just six weeks.
It could have paused in September, when by its own admission inflation would have eased within a few months and global growth was a worry.
But it went on to say that "with the likelihood of inflation remaining high for the next few months, rising inflationary expectations remain a key risk. This makes it imperative to persevere with the current anti-inflationary stance."
September's quarter point rate rise was unnecessary, says Westpac's McKay, as it meant even more risk to the growth-inflation trade-off, when a mere bias to tighten would have sufficed.
The use of words such as "imperative" and "persevere" by the central bank "reeks of puritanical stubbornness" and shows a disturbing potential for self harm, McKay observes. "The RBI seems to have elevated this decision to a moral principle."
