The significance of the Reserve Bank of India’s (RBI’s) annual credit policy statement lies not merely in its being the first for fiscal 2013-14. Until a few years ago, the annual policy statement, along with a review six months later were the only two policy statements in a year. For a variety of reasons but mainly to step up the number of interactions with the financial markets the RBI now has a policy statement eight times a year or roughly one every 45 days. Apart from the annual policy statement there are quarterly reviews and mid-quarter reviews.
The increase in the frequency does not in any way diminish the pre-eminence that the annual policy statement has: the RBI uses it to review developmental and regulatory policies also. Above all, the RBI’s dissertation of the macro economy, so eagerly awaited, is in full flow in its annual statements.
For the common man, the policy statements matter mainly because they convey interest rate changes. That is understandable because interest rates are something most people relate to, either as borrowers or depositors. But over the medium-term at least, it is hoped that even ordinary citizens will be able to appreciate the macro-economic circumstances that have prompted the interest rate changes (or preserved the status quo) in the first place. The process of demystifying official policies, so vital in a democracy, will get a boost.
The RBI cut the policy repo rate by 0.25 percentage points to 7.25 but left the cash reserve ratio (CRR) unchanged even though a reduction might have helped as there is certain tightness in the money markets.
The intention is to rely on open market operations (OMOs) rather than on CRR cut to manage liquidity. Besides, a repo rate cut works best if liquidity is in relative short-supply.
That, however, does not automatically ensure that monetary transmission, in this case, the repo rate reduction, will translate into lower interest rates of banks. As banks are quick to point out a repo rate reduction does not ensure a larger availability of funds, it can at best lead to an interest rate softening over time. But then at lower interest rates bank deposits might become unattractive.
The RBI has been influenced by rapidly decelerating growth recently and the inflation outlook. From a 9.2 per cent increase in the fourth quarter of 2010-11 economic growth slumped to 4.2 per cent in the third quarter of last year. Although wholesale price index (WPI) inflation had eased by March, food price pressures persist and supply side constraints are endemic.
In fact, inflation can never be outside RBI’s radar. There are a number of upside risks, which might prompt a reversal of the interest rate softening stance which has been in vogue since January. In RBI’s view, inflation during 2013-14 will range around 5.5 per cent.
On growth, its projection is at 5.7 per cent, much lower than what the budget and the Prime Minister’s Economic Advisory Council (PMEAC) had estimated. The RBI expects sluggish growth in both industry and services. Among the list of important risks the macro economy faces, the current account deficit (CAD) figures at the top not the least because it had reached record levels last year and expected to remain much above what the RBI considers to be a sustainable level of 2.5 per cent of gross domestic product (GDP). Second, as much as its size its financing has made the economy extremely vulnerable to the movement of short-term flows from countries which themselves face an uncertain economic outlook. Economic growth depends on a revival of investment. But investment outlook remains weak. Emphasising the point made earlier by the Economic Survey among other official documents, investment sentiment remains inhibited, with business confidence dented.
In a statement that is bound to catch popular imagination, the RBI says that both borrowers and lenders have become risk averse, the former because of governance concerns, delays in approvals and tight liquidity and the latter due to rising non-performing assets and heightened risk premia. Finally, the RBI once again renews its call for easing supply side constraints, notably in food and infrastructure without which the effectiveness of monetary policy to contain inflation and anchor inflation expectations will be undermined.