With the Government demonstrating a reform intent and inflation unlikely to worsen, a repo rate cut was a risk worth taking.

I

t is unfortunate that the Reserve Bank of India (RBI) has not gone in for even a token interest rate cut in its latest monetary policy review, despite the Government announcing credible fiscal consolidation and reform measures over the weekend to revive investor sentiment. At a time when the Indian economy is gripped by a deepening slowdown and corporates have virtually stopped taking up new project proposals, reversing this mood of despondency calls for coordinated policy response from the Government and the RBI’s end. Until now, the latter had a legitimate grouse that its flexibility for monetary accommodation was constrained by the Government not doing anything about putting its fiscal house in order. Indeed, when the RBI had, in April, cut its ‘repo’ lending rate by 50 basis points, the understanding was that the Government would complement this move by raising fuel prices and unveiling other steps to restore fiscal discipline. The Government clearly failed to deliver its side of the bargain – till last week, when it took a slew of politically tough decisions, from hiking diesel prices and curtailing subsidised LPG cylinder sales to allowing entry to foreign supermarket chains.

But now when the Government has finally acted, the RBI has refused to oblige by stating that these were “anticipated at the time of the April (monetary) policy when a front-loaded repo rate reduction was undertaken”. In other words, the Government has only made up for April; any further rate cuts will have to wait for more fuel price increases! Such a stance has little meaning in the current recessionary environment, where absorbing even the recent diesel price increase may not be easy for firms, when their margins are already under squeeze. Lower interest rates, even if not enough to offset the above cost pressures on industry, would definitely have been useful from a sentiment perspective. RBI’s action, limited to cutting the cash reserve ratio requirements for banks, would achieve neither: A 0.25 percentage points reduction would release Rs 17,000 crore for lending, which can, at best, earn Rs 2,000 crore as interest income. That’s hardly enough to make loans cheaper.

The RBI’s concerns over “persistent inflationary pressures” and the need for monetary policy to privilege this over “growth risks” is in marked contrast to the US Federal Reserve’s current resolve to maintain a “highly accommodative stance” to “support a stronger economic recovery (and) generate sustained improvement in labour market conditions”. True, the conditions here are different from the US, where inflation isn’t as much a problem. But it is a fact that growth slowdown in India is also no longer just a “risk”, but something real and probably worsening. On the other hand, inflation is unlikely to worsen, especially with the monsoon staging a recovery since August. And with the Government, too, demonstrating reform intent, a repo rate cut was a risk worth taking.

(This article was published on September 17, 2012)
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