Money & Banking

Macro-economic situation calls for a pro-growth monetary policy

Mohan Shenoi | Updated on June 11, 2012


Investment demand has failed to revive due to a combination of high interest rates and lack of timely supply-side measures.

The RBI will be announcing its Mid-Quarter Review of Monetary Policy on June 18 in the backdrop of a complex, uncertain and volatile global and domestic macroeconomic scenario.

Global scene

Advanced economies have exhausted their fiscal and monetary stimulus options. Moreover, the stimulus which has already been administered by them is not resulting in favourable economic outcomes.

Instead, it is only resulting in adverse market outcomes. The contours of European Monetary Union have made it almost impossible to administer monetary policy actions that are appropriate to all its members at the same time.

Whether global markets experience a “risk-on” rally or a “risk-off” decline will be determined by the outcome of the new legislative elections in Greece scheduled on June 17, a day before RBI's policy review.

Given the recent testimony by US Fed chief, Dr Ben Bernanke, to the Congress, the likelihood of his announcing a third round of quantitative easing (QE3) in the FOMC meeting scheduled on June 20 looks very remote.

A dramatic fall in Brent crude oil prices to $98 a barrel and reduction in gold imports in the first two months of the fiscal has to some extent reduced the pressure on India's current account and balance of payments (BoP).

Consequently, the rupee depreciation has for the moment stabilised in a range. However, a “risk-off” decline in global financial markets could potentially re-exert pressure on the rupee.

Easing global commodity prices, particularly that of base metals, has been instrumental in keeping core inflation benign.

Significant demand destruction has happened in the last few months. Investment demand has failed to revive due to a combination of high interest rates and lack of timely supply-side measures.

All this has resulted in growth slowdown which has been much more pronounced than that witnessed during the post-Lehman period.

Fiscal correction

However, measures for fiscal correction are yet to be initiated by the Government.

The Government's subsidy bill is expected to remain at elevated levels due its reluctance to increase administered prices of petroleum products such as diesel, kerosene and LPG.

The revenue side will also be under pressure owing to the slowdown in tax collection and difficulty in conducting disinvestment.

On balance, the monetary policy can now initiate pro-growth measures even as it continues its focus on controlling inflationary expectations.

Average liquidity deficit in the money market has been around Rs 85,000 crore. The advance tax outflows around June 15 could increase the liquidity deficit to in excess of Rs 1,00,000 crore. Since liquidity and interest rates are two faces of the same coin some measures to infuse liquidity into the system are also likely in the policy.

Rate cuts

Given this situation, one can expect a 25 basis point cut in policy rates (repo and reverse repo) and a 50 basis point cut in the Cash Reserve Ratio (CRR) in the RBI's Mid-Quarter Review.

The reduction of policy rates, however, is only one part of the story. For growth to pick up, it has to be urgently accompanied by strong policy actions by the Government, including movement in the second generation reform process.

(The author is President, Group Treasury and Global Markets, Kotak Mahindra Bank. The views expressed are personal.)

Published on June 11, 2012

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