The Reserve Bank of India has managed a delicate balancing act in the third quarter review of monetary policy 2011-12 unveiled on Tuesday. The reduction in cash reserve ratio (CRR) by 0.50 percentage point to 5.5 per cent will somewhat ease the tight liquidity conditions in the money market, while the decision to leave interest rates unchanged sends a clear signal that the apex bank is still not comfortable with the overall picture on inflation. With economic growth visibly slowing down — something the apex bank acknowledges — there was pressure to start the rate reduction cycle. But there are three major worrying factors on the inflation front. First, non-food manufactured product prices continue to be high; much of the drop in inflation in recent weeks was due to a fall in the prices of vegetables and seasonal products. Secondly, suppressed inflation in the form of artificially held down prices of petroleum products is quite significant. Finally, the depreciation in rupee value has also been feeding into core inflation. Given these, it was unrealistic to expect the RBI to embark now on the rate reduction cycle. However, the central bank has done its bit to encourage credit off-take by infusing liquidity (Rs.32,000 crore) through a reduction in the CRR. Despite the RBI's open market operations injecting Rs.70,000 crore over the past two months, money remained scarce, affecting credit flow to borrowers.

So, what are the prospects for the rate reduction cycle commencing soon? Not very bright, it appears. A lot depends on what the government does in the budget for 2012-13. The RBI is clear that the budget should come up with policy initiatives to induce investment and concrete measures for fiscal consolidation, if it is to start pegging rates down. This, especially the latter, is easier said than done. There are several factors that could impact the economy adversely. Not the least of them is the uncertainty in the euro zone, let alone the falling capital inflows in the context of a widening current account deficit. Inflation could once again spiral upwards if fuel prices, especially of diesel, are raised, as they should be. The escalating tensions over Iran portend more trouble, as they could drive up global oil prices forcing the government to pass the burden down the line. Adding wind to the inflationary sails will be a hardening of food prices, especially vegetables, which usually happens with the end of winter. All these, combined with the lacklustre investment climate as evidenced by the declining levels of non-food credit off-take, means that there is enough for the RBI to worry about before it makes up its mind on turning around the interest rate cycle.

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