The RBI wants inflation down at 7 percent by the end of the 2008/09 fiscal year in March. It stepped up monetary tightening aggressively in June and July as inflation, driven by high fuel and commodity prices, headed for double digits.
The benchmark lending rate is at 9.0 percent, its highest in seven years, and the central bank has also tightened banks' reserve requirements to stop surplus cash stoking prices.
The effect of tightening monetary policy had directly fall on the interest rate of Loans where both SME's and household got effected. The tightening monetary policy has also showered its curse on the growth of the SME Sector.
While economists expected Dr. Subbarao to keep the central bank's anti-inflation stance with tightening monetary policy, as a Bank regulator it is yet to experience what would be his stance on opening up the Banking sector to more foreign Banks.
Further,there are real concerns about how he would handle the relationship between the finance ministry and the central bank as the government heads towards national polls due by May, with India's budget pressured by subsidies and policies such as a loan waiver for poor farmers.
While the central bank has gained greater independence in recent years, the finance minister has often urged banks to keep their interest rates steady to ensure credit flow for development, even as the RBI was raising them.Dr Subbarao's task will be tricky. Long term, the government wants the $1 trillion economy to grow 8-10 percent a year to reduce poverty and create jobs but it has slowed from annual rates of 9 percent or more in the past three years.
At the same time, as elections loom, policy makers are concerned inflation will be a ballot box issue as it hits India's millions of poor the hardest.
The challenge is the growth rates have to go up to 10 percent to fight poverty and deprivation. At the same time, inflation will have to be kept under control given the political expectations in numerous elections coming up. Inbetween , Dr Subbha rao has to really do a lot of balancing act to make the both side of equation, in a stable condition. Once this balance is achieved , it could be really good news to SME's.