The wisdom of waiting

The Reserve Bank of India (RBI) has wisely refrained from raising interest rates or reserve requirements on banks in its mid-quarter policy review. This is contrary to market expectations of a minimum 25 basis points increase in its benchmark repo or lending rate, following consumer price inflation surging to 11.24 per cent in November. The RBI’s action shouldn’t be viewed as an intention to surprise — even if Raghuram Rajan has managed to do this unfailingly since becoming Governor — as much as the need to be slightly ahead of the curve. Even when it comes to inflation, a central bank’s policy stance must be guided not by the present but the likely future course of prices. There is reason to believe that food inflation has peaked, being already low or negative in many agri-commodities: from sugar and edible oils to pulses and coarse grains. Even onion — the humble bulb that has brought tears to the aam aadmi and the Congress alike — has seen wholesale prices tumble by nearly 40 per cent since the start of this month.

That being so, the RBI has rightly decided against an “overly reactive policy action”, and to wait for the “next round of data releases” before embarking on any further monetary tightening. It is incorrect to see this approach as being ‘soft’ on inflation. Instead, it is realistic, given that India is poised for a bumper agricultural harvest this year, thanks to a very good monsoon. Its effects have not been felt fully on prices only because of delayed crop arrivals from extended rains. No great harm would befall the economy from waiting till at least mid-January. By clearly stating it will act — “including on off-policy dates if warranted” — in case the expected softening of food inflation does not materialise, the RBI has spelt out a stance that is far from dovish.

Raising rates also makes no sense in a scenario of slowdown that is virtually secular — extending from manufacturing and investment to services and consumption. The likely — indeed, necessary — tightening of government spending in the next quarter to meet the Centre’s fiscal targets will only add to the current demand contraction pressures. The RBI under Rajan has done a great job in stabilising the rupee and rebuilding its forex reserves through out-of-the-box moves such as offering concessional swap facilities to banks for mobilising non-resident deposits and overseas borrowings. The reversal of its exceptional monetary measures of July, along with the introduction of floating-rate repo auctions, have also helped considerably ease the liquidity stress that banks and corporates were experiencing till quite recently. With the rupee now stable and much improved liquidity conditions, one hopes that vegetable prices, too, would oblige to enable what the RBI should do next: cut interest rates.

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