The Reserve Bank of India (RBI) may have disappointed many by keeping the key interest rates unchanged. But it let the cat out of the bag when it sort of set the term for dropping interest rates. In essence, the RBI has put the onus on the government. “Strong signs of fiscal consolidation are critical to create the space for lowering the policy rate,” it said in its third quarter review of monetary policy 2011-12. It had even gone a step further. It advised the government to “exploit the forthcoming Union Budget” to “begin this process in a credible and sustainable way.”
The signal is crystal clear. Monetary measures alone won't suffice. The government must do its bit. Though the apex bank has been, time and again, stressing the need for fiscal discipline, the government, led by the political class, is paying less than genuine heed to its call. Not surprisingly, the RBI asserted that the timing and magnitude of future rate actions hinged on a number of factors. In this context, it pointed to the ‘significant threat' posed by fiscal slippages to inflation management and macro-economic stability.
The below-projected 15.7 per cent growth in non-food credit, according to the RBI, was the consequence of a significant expansion in net bank credit to the government, which had grown to 24.4 per cent compared with 17.3 per cent last year. In the light of increased government borrowing, the apex bank is expecting the gross fiscal deficit for 2011-12 to overshoot the budget estimate substantially.
“This could potentially crowd out credit to the private sector,” the RBI said. This surely will spell consequential risk to the economy by adding up to the inflationary pressures.
With the political leadership unable to act decisively on the diesel subsidy, the RBI had chosen to do some plain speaking. “It will be prudent to fully de-regulate the diesel prices to contain both aggregate demand and trade deficit,” it said. Will the government listen? By talking freely about the “presence of suppressed inflation in still large measure,” the apex bank implied that the government had a lot to do on this score. Notwithstanding its open market operations to inject over Rs.70,000 crore into the system, the RBI found the liquidity conditions “tight beyond its comfort zone.” The inability of the apex bank should partly be explained by its own concerns and actions related to depreciating rupee.
The central bank indeed finds itself in an acutely uncomfortable spot.
The policy paralysis at the political level has made its task lot difficult and risky at the moment. The onus is now on the fiscal managers to gather courage and move decisively. Until that happens, it is hard to expect monetary actions to have the intended effect on the economy.
