The second quarter monetary policy review has further reinforced the Reserve Bank of India’s credentials as a pragmatic inflation fighter, not swayed by either market expectations or overt signals from the Finance Minister favouring a cut in policy rates. The traditional monetary policy dilemma of supporting growth versus reining in inflation has remained. Growth considerations are behind the decision to lower the cash reserve ratio (CRR) by 0.25 percentage points — to release Rs.17,500 crore of primary liquidity — while leaving the repo rate unchanged. Thus over two consecutive policy statements, the RBI has chosen to influence interest rates through liquidity-augmenting CRR reductions rather than through the more traditional method of policy rate cuts. The expectation is that fresh injections of liquidity will induce banks to lower interest rates. A repo rate cut, on the other hand, might convey the impression that the central bank is loosening its monetary policy prematurely. In the event, the RBI has done well to emphasise the point that managing inflation and inflation expectations must remain the core focus of monetary policy, especially when inflationary pressures have persisted even as growth has moderated. Headline inflation for September has been at a 10-month high of 7.8 per cent and is expected to ease only by the fourth quarter of the year. Of particular concern has been the stickiness of core inflation due to supply constraints and the cost-push effects of the rupee’s depreciation. The RBI has raised its inflation forecast for March 2013 to 7.5 per cent from 7 per cent indicated in July.
In line with expectations, the RBI has lowered its growth forecast for the current year to 5.8 per cent. Almost all private forecasters and several international agencies, including the IMF, have already downgraded India’s growth prospects. The slowdown is attributed to the worsening global environment, weak industrial activity and slower than anticipated growth in services. The large current account and fiscal deficits continue to pose significant risks to both growth and macroeconomic stability. The RBI has obviously not been swayed by the government’s recent policy announcements aimed at attracting foreign direct investment. They might have positively impacted sentiment, but need to be followed up with concrete action on the ground to revive investment. Much also depends on how efficaciously the government implements the fiscal consolidation map outlined by the Finance Minister on Monday, according to which the fiscal deficit is to be contained to within 5.3 per cent of GDP by March 2013 and then to 3 per cent over a five-year period.
