Overly cautious

Both the second monetary policy statement for this year and the subsequent press briefing have failed to explain why a rate cut was not effected to revive a slowing economy. The factors favouring a cut seemed compelling. Investment as a share of GDP has been on the decline for the last five years; it has fallen sharply since 2014. Gross fixed capital formation was 29.5 per cent of the GDP in 2016-17, against 30.9 per cent the previous year. Growth in the four quarters of 2016-17 has been on the decline, despite a bountiful monsoon and a revival of sorts in the OECD countries. Retail inflation at 3 per cent is well within the MPC target of 4 per cent (with a leeway of two percentage points either way). The Met has upped its monsoon projections to 98 per cent of the long period average, dispelling immediate food inflation fears. A Fed rate hike is unlikely to rock the rupee, going by its recent rise despite the December 2016 hike. So the RBI’s contention that it needs more clarity on what the growth and inflation numbers imply before it can cut rates, is bewildering. Nor is it possible to be convinced by its view that “imminent” implementation of the house rent allowance component of the Pay Commission and “imported inflation” (whatever that means in a time of benign commodity prices) persuaded the MPC to stay its hand. What’s more, the RBI’s focus on relieving banks of its stressed assets burden would have been well served by a rate cut. It would have helped them reschedule loans and offer lower rates, while at the same time protecting the real returns of savers. If the MPC fears that lower rates will prompt the government to borrow recklessly and crowd out private borrowings — a stance reflected in a remark of the RBI Governor — that too seems out of place in a time of weak private investment demand.

It appears that the MPC has fallen into the good old monetary policy trap — of exaggerating fears of inflation (it seems to be actually targeting 4 per cent or maybe less), and altogether neglecting the bigger threat looming on the growth and jobs front. Not surprisingly, Chief Economic Advisor Arvind Subramanian recently observed that monetary policy has “over-achieved” on inflation, and by implication ‘under-achieved’ on growth. To be fair, the RBI has relaxed provisioning for the housing sector, arguing that the “backward and forward linkages” of this sector can boost the economy. It has indicated that a rate cut is on the cards next time round, presumably when it gets a ‘grip on the data’.

But monetary policy is also about timing. This was a window of opportunity, given the absence of volatile external and internal factors. If fears crop up on how the GST will play out in the initial stages, the MPC may again find itself in a quandary.

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