Speculation as to whether there will be a rate action or not remains rife even as the Reserve Bank of India prepares to announce its next instalment of monetary policy on Tuesday, August 4. This is despite the fact that consensus among experts is for no rate action, meaning that central bank will not effect any change. A similar consensus had emerged in June also. That was proved right by the RBI holding the rates in June. The absence of a rate cut seemed vindicated as CPI inflation numbers for June were higher than for the previous month.
Since then however, the pressure on food prices appear to have eased a bit. At its mid-way mark, the South-West monsoon has been spatially well distributed and does not appear to be as deficient as was feared. As for agriculture, even pulses, whose inadequate supply has underpinned food inflation, seems to have recovered. Taking a cue from the recently announced minimum support prices, farmers have been shifting to pulses. The easing of pressures on the food front has been accompanied by the fall in petroleum prices which are at their six-month low.
However, it is too early to pronounce a favourable verdict on the rains. The impact of the monsoon on growth during the second-half of the year will be crucial.
Not everything is hunky dory, however. The real economy is yet to gain momentum. Industrial output, as measured by the IIP numbers, is sluggish. Bank credit disbursements are running below their targets. Corporate results for the April-June quarter do not give any scope for optimism. The big jump in indirect tax collection seems out of line with other developments, and, in any case, requires corroboration.
In such a situation, the RBI’s traditional dilemma whether to cut rates or not, becomes even more acute. But that is not all. What make the task of monetary policy particularly arduous this time are two developments.
First, the U.S. Federal Reserve has indicated its intention to finally increase its policy rates from their rock bottom levels. This widely anticipated move is expected to draw in footloose private capital. Many others, including portfolio managers and institutional investors, might decide to go back to the U.S. The likely impact of all this on India’s external situation is fuzzy at the moment. But everybody concedes that there will be a pressure on the rupee and interest rates, which may have to be pushed up to retain a chunk of foreign money, which has become all important for the country’s balance of payments. Many other experts opine that the consequence of a U.S. rate hike will not be as severe as feared. After all, investors too need a safe place to put their money in. India will continue to remain attractive, with its economy growing at a fast clip.
The second development is more ominous, and is specific to India. Invidious efforts to dilute the role of the RBI in monetary policy need to be resisted. The need is to strengthen and not weaken the inflation-targeting approach of the central bank. It is conceded that a monetary policy committee (MPC) is better suited to decide on interest rates. At present, the Governor consults an advisory committee but is not bound by its advice. A committee approach is better suited. Among its other advantages, it is more transparent. A controversy has arisen as to its composition. Recently, the government released a draft of the Indian Financial Code (IFC) which recommends that government-appointed members should be in the majority. Further, a provision that in exceptional circumstances the RBI governor can veto the recommendations of the committee has been dropped.
With this, an already simmering controversy has flared up. Various suggestions to implement the IFC without compromising on the RBI’s powers are doing the rounds. The formalisation of an MPC should be ideally done by next year when the new inflations targets set by the Urjit Patel Committee set in. It is hoped that monetary policy formulation is spared further controversies some of which are unseemly to say the least.
It is important to realise that monetary policy works best in an atmosphere of mutual trust between the RBI and the government. Moreover, from the point of view of financial markets, the confidence that the present Governor enjoys is invaluable and nothing should be done to undermine it.
At another level, the performance of major public sector banks, as revealed by the financial results during the first quarter, is a stark reminder that the problem of non-performing assets will not go away. The problem, more acute with each passing quarter, by reducing the capacity of banks to lend, significantly hinders economic growth.