The Hindu Business Line : Fed reassures markets, mothballs inflation fears

There are few, if any, similarities between the US and Indian situations. Yet the case for rate reduction remains and the RBI knows it. It only believes the time is not ripe for one.

S. Balakrishnan

In its Quarterly Monetary Policy Review, the Reserve Bank of India kept the repo, reverse repo and CRR rates unchanged.

It was thought – admittedly a minority view - that the central bank would effect a 25-basis point cut in the repo rate, given the global market turmoil and the aggressive rate cuts of the Fed.

In his pre-review statement, the Governor underlined the risks still posed by inflation.

He was right in saying that price pressures have been suppressed because energy prices have not been adjusted to reflect their higher global prices.

Little similarity

There are few, if any, similarities between the U S and Indian situations.

The American economy is sputtering. The housing sector is in deep recession. The balance sheets of banks are in bad shape and urgently in need of capital.

In contrast, Indian economic growth, though slowing, is still strong. Realty is booming and stocks quickly recovered from a brief carnage. The burden of proof for softening rates is on those arguing for one.

Yet the case for rate reduction remains and the RBI knows it. It only believes the time is not ripe for one.

Thus the review has an escape clause stating that global developments will be closely watched and there will be an appropriate and timely response if and when necessary. Translation: if the Fed continues rate-cutting and US rates fall too sharply, we will be left with no choice but to follow.

Disconnect

But will it pass through to the market? There is a disconnect between liquidity in the banking system and deposit and lending rates.

Despite the market being flush with funds for most of the last year, low inter-bank rates have not brought down banks’ liability costs nor have borrowers benefited, except for the largest corporates, over whom banks fall over one another to offer funds at sub-inter-bank rates.

What meaning and significance then for the central bank’s policy rates and changes in those rates?

Theory talks of the transmission effects of the interest rate actions of a central bank - but only if, in fact, they are transmitted.

What, meanwhile, of the outcome of the two-day Fed meeting?

The Fed made its intentions clear with its dramatic 75-bps cut a week before. There seems no question that it has decided to keep at it till it sees stability restored to asset markets.

The post-meeting statement assures soft and softening rates are alive and well till growth risk is out of the equation. Inflation fears are mothballed for the present.

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