The Reserve Bank of India in its mid-quarter monetary policy review on Monday effected no changes in either the repo rate or the Cash Reserve Ratio. This was entirely anticipated by the market participants. The sharp rupee depreciation in relation to the dollar over the past one month has loomed large in the RBI’s calculations. Traditional policy dilemmas relating to growth and inflation do exist but they acquire a new edge in the light of the rupee’s fall. Between April 1 and June 14 the rupee declined by 5.8 per cent. It fell by 6.6 per cent between May 22 and June 11 and is threatening to race downwards towards new lows. What is particularly worrying is that the rupee’s aggravated decline has been caused by a sell-off by foreign institutional investors who were reacting to as yet unconfirmed news of a possible tapering off of quantitative easing by the U.S. Federal Reserve. At a very basic level, this has exposed the serious vulnerabilities of India’s balance of payments, especially in the context of a persistently high current account deficit. Even the most optimistic predictions do not place the CAD significantly below 5 per cent of GDP at the end of March 2013. Adding to the government’s woes, the trade deficit is expected to remain high in the foreseeable future. Higher tariffs and administrative measures to curtail its demand have not significantly reduced gold imports.

Fortunately, there has been some good news on the inflation front. Having eased for three months in a row, headline WPI inflation is down to 4.7 per cent in May and is considerably below the 7.4 per cent average of 2012-13. All constituent categories, with the major exception of food, have moderated. While the closely watched non-food manufactured inflation too has ebbed, the inflation outlook going forward is by no means benign. The rupee depreciation is a major reason: dearer dollars mean higher prices for imported fuel and edible oil. Other factors dampening the outlook are possible revisions in administered prices, including minimum support prices of various commodities. Retail inflation remains high at 9.3 per cent in May. In the RBI’s view “it is only a durable receding of inflation that will open the space for monetary policy to address growth risks.” Therefore, despite the obvious evidence of a slowdown that would normally invite supportive measures, it believes prudence lies in pausing and not continuing with the monetary easing that appeared to have taken hold over the past few policy statements. Framed in the shadow of the rupee’s sharp depreciation, the mid-quarter monetary policy review is a dissertation that transcends more conventional arguments for or against monetary measures.

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