FINANCIAL SCENE The RBI has made it amply clear that monetary policy action, at any given point, will be determined by its reading of the macro-economic situation, especially inflation and growth.
The mid-quarter monetary policy review unveiled by the Reserve Bank of India (RBI) on June 18 grabbed headlines not so much for what it did but for what it did not. Large expectations of an interest rate cut, along with other forms of monetary easing such as a CRR (cash reserve ratio) reduction, were built up during the run-up to the policy announcement. So much so, the question was not whether, but by how much, the RBI would lower the repo rate and/or the CRR.
In the event, the decision of the central bank to leave the policy rates and the CRR unchanged was the big news. It is not as though those who assumed that an interest rate cut was on did not have a case. Such clamour is seen on the eve of every credit policy review. But giving considerable weight to the argument this time has been a slew of weak macro-economic numbers pointing to a slowdown.
Contributory factors
Economic growth slowed down over successive quarters of last year to touch a low of 5.3 per cent during the January-March 2012 quarter. For the whole year, it was 6.5 per cent, a nine-year low. Deceleration in industrial production, from the supply side, and weak investment demand, from the demand side, have, in particular, contributed to the slowdown. The index of industrial production (IIP) increased by just 0.1 per cent in April. In times like this, a monetary stimulus through a rate cut is recommended.
There was another reason why a rate cut was considered imminent. In its annual credit policy statement of April 17, the RBI announced a larger-than-expected 50 basis points cut in the policy rates. Since the RBI had, for quite sometime before, been hinting at an end of a rate tightening circle, the annual policy statement was taken to be the starting point of an easier interest rate policy which will be continued in the next credit policy review. However, two months later, when the RBI held on to the rates, it was not thought of as a pause, which it is, but a reversal of recent monetary easing.
Maintaining status quo
Whether it has merely paused or abruptly ended its relaxed interest rate stance is not particularly relevant. The RBI has made it amply clear that monetary policy action, at any given point, will be determined by its reading of the macro-economic situation, especially inflation and growth.
The decision to maintain status quo has been guided by the fact that inflation remains a potent force. WPI inflation for May has been at around 7.55 per cent (7.23 per cent in April) on the back of high food prices.
Consumer price inflation remains in double digits. The only saving grace - the moderation in core inflation (inflation, excluding the volatile food and fuel items) has remained at below 5 per cent - is not a good enough reason to effect interest rate cuts. Upside risks to inflation continue to remain strong.
The RBI has also put forth the argument that interest rates have a limited role in reviving growth at this juncture. Factors other than interest rates have contributed to the slowdown. A turnaround in growth driven only by lower interest rates is unlikely given the poor investment climate. Lower interest rates can help stimulate consumption demand through its positive impact on retail credit but cannot lead to a sustained investment activity unless complemented by steps aimed at policy-related bottlenecks.
A rate cut is not the right medicine for curing the ills of the economy also because it would have added to inflation risks. The weaker rupee might cause higher imported inflation risks. Should the government eventually raise diesel and kerosene prices to contain the subsidy bill, inflation and inflation expectations will go up. The hike in excise duty and service tax will be a contributory factor.
The RBI, almost certainly, has to reckon with India’s twin deficits — fiscal and current account — before deciding on interest rates. Urgently needed steps aimed at fiscal consolidation, which the union budget promised, have not materialised.
Sentiment
It may be arguable, but an interest rate cut would probably have had the psychologically important consequence of preserving, if not boosting sentiment such as what is seen in the stock markets. The counter argument is, for that to happen the rate reduction ought to have been of a higher magnitude, say at least 0.50 percentage points. Besides, it is extremely doubtful whether sentiment can be sustained over the long-term through rate cuts and other short-period monetary measures.
Keywords: RBI, Indian economy, monetary policy, cash reserve ratio, repo rate, interest rates
RBI has digested the fact that the tool of CRR rates are no longer
viable to control inflation and accelerate the economic growth. However
said so, the 25th June announcements by RBI will definitely boost up the
FII's and production/ manufacturing indices which RBI is no longer able
to drive through varying reverse rapo rates. On the other side, we
should not expect any miracle out of today's announcements but should
see from the window some hope of pausing economic slow down and drowning
rupee against dollar.
Emprical evidences and historical experiences clearly demonstrated that the monetary policy can target inflation only and if the policy target both inflation as well as growth, then reaching closure to one target will take away from the other target. The deceleration of Industrial and service sector growth must be obviously caused by the decreasing external demand driven by the pass-on effects of slow down of US Economy and Euro meltdown. Under such an environment interest rate cut and reducing the CRR will not be a solution but will add to the problem. First, monetary easing might increase domestic demand and push the inflation further. With higher inflation our competitiveness will be lost that might lead to declining exteral demand. All this will adversely affect investors confidence and therefore investment will be shrinking as it is happening. Many a time economic managers pretend to act but their actions,knowingly or unknowingly, lead to adverse outcome.
To what extent will a rate cut be helpful? Already the retail consumer is crowded off the market due to the high costs of all products. So a decrease in interest rates by 1% will certainly not make a big difference in his decision to buy anything other than the basic necessities. Only the upper middle class and upper class people have the dough and means to buy the white goods. And for them, the interest rates do not matter
Good work by our RBI Governor - in holding the rates.
I think what RBI did is right. If it had lowered down the interest
rates, nobody could have stopped the rise in inflation. RBI has to
see the macroeconomic scenario as that is where the larger
interests lie. It presents the global picture of the country.
Well, what happened last week was the stock markets tanked further, the rupee dipped further to Rs 57 against the dollar, adding further to the inflationary pressures. The RBI then can two months later continue to cite inflationary pressures and say no to rate cuts again. And thanks to already high fiscal deficits, the government has zero wiggle room for a stimulus package. May be come this week, the government may announce measures to ease bottlenecks, and may be soon thereafter the RBI will bring the scissors again. Will keep our fingers crossed..
Please Email the Editor