Are rate cuts the way to go? - NO

The Monetary Policy for 2013-14 is Governor D. Subbarao’s last Annual Policy Statement. Kudos to Governor Subbarao for having prevailed with a cautious policy. Top policy honchos in the Government have been, with unprecedented ferocity, rooting for easing monetary policy. It is easy for commentators to say that the Reserve Bank of India (RBI) should assert its independence and not respond to the clarion calls from the Government, but this is easier said than done. In the halcyon days of the 1990s the Government made no statements prior to the monetary policy. In today’s world, government honchos publicly state what they would like monetary policy to do. Given the ground realities, Governor Subbarao has yielded the minimum relaxation possible.

There are two constraints which warrant a cautionary monetary policy. First, although the Wholesale Price Index (WPI) has come down to 6 per cent by the end of March 2013, the Consumer Price Index (CPI), as per the new combined rural-urban index, is still well into double digits. This is of great concern especially as price indices, the world over, understate inflation. The CPI is the standard measure of retail inflation, used for policy purposes, and it is time the Indian authorities recognise the CPI as the appropriate indicator of inflation. If this were done, much of the enthusiasm to push the RBI into relaxation of monetary policy would wane. The RBI is more cautious about growth in 2013-14 (5.7 per cent) as against the government’s projection of 6.4 per cent. It has rightly stressed that the growth-inflation dynamics yields little space for further monetary easing.

The biggest risk to the economy stems from the balance of payments’ current account deficit (CAD) which was over 5 per cent of GDP in 2012-13. A CAD of this size leaves the economy vulnerable to severe external shocks.

A CAD which is easily financed in one period becomes difficult to finance in another. In many policy circles, it is argued that the fall in crude oil and gold prices portend a fall in the CAD. There is a fundamental flaw in this argument.

The CAD is nothing other than the gap between investments and savings. Bringing down policy interest rates is hazardous as all it would do is to reduce household sector financial savings. In the best interests of economic stability, effective measures need to be taken to quickly step up household sector financial savings.

In this context, the Government should totally back off from overt or covert pressures on the RBI to ease monetary policy

.(The author is an economist.)

Also read: Are rate cuts the way to go? - YES

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