Rajan holds firm on policy

The Reserve Bank of India on Tuesday left the repo rate unchanged at 7.25 percent. The repo rate is the rate at which the central bank of a country lends money to commercial banks in the event of any shortfall of funds. In addition, it also maintained the cash reserve ratio, which is the proportion of deposits banks have to park with the central bank, at 4 percent. Much to the chagrin of the Union Finance Ministry and members of Industry, the RBI practiced a great deal of prudence and caution in their approach to monetary formulation policy, while maintaining “the accommodative stance of monetary policy”. 

The RBI’s monetary policy stance, which some argue errs on the side of caution, stems from a lack of clarity over the distribution of rain in the current monsoon season and the resultant effect on the farm sector. On the food inflation front, the RBI will continue to monitor the Centre’s ability to break supply side bottlenecks, like the unavailability of land and slow electricity generation capacity.  

Until conclusive data on the spread of rainfall over the monsoon season is forthcoming, the RBI, some argue, will maintain its tone of caution. One look at the RBI’s monetary policy statement and it is apparent that fears of potential inflation have held it back from reducing the repo rate. “The June reading of 5.4 percent has resulted in the projections being elevated, but will meet the 6 percent target for early 2016. Hardening of inflation, excluding food and fuel, is most worrisome. The impact of the hike in service tax rates to 14 percent in June will flow into the inflation reading through the year,” the statement said. 

The central bank, however, did express confidence over India’s prospective growth rate, which it said would hover around 7.6 percent. The outlook for growth is improving gradually, it said, adding that favourable real income effects could accrue from weaker commodity prices, in particular, crude oil and a possible step-up in agricultural activity if monsoon season continues to improve. Besides fears of inflation, the policy statement was a continuation of the central bank’s offensive against public and private sector banks. According to the RBI Governor Raghuram Rajan, banks have only transmitted 30 basis points of its 75 in rate cuts so far. One basis point is equal to 1/100th of 1 percent. In response, Arundhati Bhattacharya, chairman of the country’s largest lender State Bank of India, replied that its lending rates were not merely determined by the RBI’s repo rate. Any such action, she argued, would also depend on economic growth and other market factors.

One the key highlights from the RBI’s monetary policy review was a confirmation that the RBI and government have reached a consensus on the composition of Monetary Policy Committee (MPC) and what the Governor’s power would be. However, further details were not forthcoming. Although Rajan echoed the government’s stance on the removal of veto powers for the Governor, he maintained his opposition against outside interference by government appointees, who do not hold office in the central bank. 

This fundamental opposition to the government’s designs comes on the back of its dubious desire to cut the central bank to size by bringing in four of its appointees to a proposed seven-member committee espoused by the latest draft of the Indian Financial Code.  The emphasis, according to Rajan, should be towards “institutionalising the process of monetary policy formulation”, instead of giving further powers those who run the risk of being considered rubber stamps of the government.