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The RBI’s move of reducing policy rate by 25 basis points was along expected lines. However, liquidity easing by a cut in cash reserve ratio (CRR) by 25 basis points was unexpected. In the recent past, while the RBI was controlling demand by monetary tightening, loose fiscal policy and suppressed inflation were preventing the central bank from taking any monetary easing measures. Although the retail and headline inflation are still high, core inflation is inching towards the 4 per cent mark. Steps taken by the Government since mid-September 2012 have reduced the fiscal slippage. The diesel price roadmap, although it has direct inflation impact, has reduced the suppressed inflation to a certain extent.
Prickly issues
Presently, both fiscal and monetary policies are moving to achieve the goal of reducing fiscal slippage and support growth. Tuesday’s move will have a positive impact on rate-sensitive sectors such as housing, consumer goods and automobile.
The crucial question is whether monetary easing will lead to a sustained investment growth revival, and thus economic growth. Low interest rate is a necessary but not sufficient condition for investment demand. Currently, the real interest rate is marginally positive (based on WPI inflation) and negative (based on CPI inflation). Going forward, the pace and stability of investment demand would depend on how quickly the Government is able to resolve issues related to land acquisition, project clearances and environment clearances.
Once these three crucial issues are sorted out, the pace of investment intention would increase and pace of projects shelved would decline. Going forward, the role of the recently announced Cabinet Committee on Investment would be very crucial for revival of investment demand.
Budget proposals
The revised 2012-13 growth projection of 5.5 per cent, same as the consensus estimates, looks plausible. However, the March 2013 inflation projection of 6.8 per cent, with diesel price roadmap, is slightly optimistic.
Recent developments on the goods and services tax (GST) front are encouraging, although the probability of implementation of GST from April 1, 2013, is low.
The monetary policy stance for 2013-14 would largely depend on proposals of the Budget (in late February 2013). A credible fiscal consolidation roadmap and Government action on land and project approval issues would help the RBI to ease monetary policy further in 2013-14.
(The author is Chief Economist and Head – Public Finance, India Ratings)
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