Millennium Post

Subbarao’s first line of defence

Amid wide expectations with growth at a decade low, and sustained pressures from the finance minister, the Reserve Bank of India  (RBI) further eased monetary policy with a second quarter percentage cut in the repo rate to 7.50 per cent, with immediate effect. The RBI had made a similar cut on 29 January. These cuts are designed to help investment revival.

Thus, in the current fiscal year (April-March), the policy lending rate has been reduced by one full percentage point, from 8.5 to7.5 per cent inclusive of the latest cut. (In the annual monetary policy for fiscal 2012-2013 in April last year, RBI made a 50 basis point cut lowering the repo rate to eight per cent from a peak 8.5 per cent hoping to trigger an economic rebound).

But cuts so far had not made any significant impact on investment or growth. Nor did headline inflation trend down until January 2013. Till then, WPI inflation had averaged above eight per cent, reducing scope for monetary easing over the first nine months.

In making this second cut in 2013 on a macro-economic assessment, RBI’s mid-quarter policy on 19 March took note of the weakest growth in the third quarter (Oct-Dec) at 4.5 per cent but inflation remaining at a level ‘not conducive for sustaining economic growth’. The slowdown extended to the services sector, mainstay of economic growth. The non-food manufacturing products inflation (core) however, had moderated in February.

With the cut in key policy lending rate to 7.5 per cent, the reverse repo rate is down to 6.5 per cent while the marginal standing facility (MSF) and bank rate are at 8.5 per cent respectively.

The mid-quarter policy review also takes note of government’s ‘firm commitment’ to fiscal consolidation but emphasises it has to be both in terms of quantity and quality. More than rate cuts or fiscal consolidation, the critical role in boosting investments is in (government) easing the supply bottlenecks and improving governance to ensure timely project implementation. Indeed these are what investors and corporates have been demanding of government to stimulate investment and growth.

RBI hopes its policy easing would no doubt contribute toward a competitive interest rate regime which, it says, is necessary but not sufficient for investment revival. The pre-requisites again include bridging of supply constraints and effective governance even as government keeps on the course on fiscal consolidation.

The latest policy review has not referred to liquidity, an issue on which the finance minister had expressed the hope RBI would address it. The cash reserve ratio was lowered in the third quarter policy in January to augment liquidity with the banking system. Apparently, RBI does not see need for a further cut in CRR at present.  It says it would manage liquidity through various instruments, including open market operations (OMO), so as to ensure adequate flow of credit to productive sectors of the economy.

But a major concern still surrounds the course of inflation during the new fiscal year beginning April. WPI in February was at 6.68, slightly up from January’s 6.6 per cent. Worryingly, CPI inflation had ratcheted up closer to 11 per cent over the last few months. In February, CPI was at 10.9 per cent reflecting mainly food prices, specially cereal and protein items.

The government’s perception of an inflation on the declining path is not exactly shared by RBI. Even at 6.68 per cent, WPI in February was above RBI’s comfort zone though the core inflation had moderated to below four per cent.  RBI’s current assessment is that headline inflation would remain range-bound at current levels during 2013-2014.

The factors which seem to militate against a decisive moderation in the threshold levels of headline inflation include the unrelenting rise in food inflation, demand-supply imbalances, the element of suppressed inflation in administered prices (oil and fertilisers), the vulnerability on the external front (with high current account deficit) which could affect capital flows and above all, the sluggish global growth. Weak external demand has slowed activity in many developing economies.

Overall, in managing the growth-inflation dynamics, the RBI stance has shifted its emphasis partly to addressing the growth risks (through rate cuts as warranted on the basis of emerging data) but contrary to expectations raised earlier that the monetary policy could increasingly get more growth-focussed, the macro-economic conditions and unrelenting inflationary pressures seem to constrain a course of steady policy easing. Listing all the risks for growth as well as the inflationary factors, RBI has come to the conclusion that as seen at present, with most of the challenges for macro-economic stability to be addressed, the outlook is one of the headline inflation not declining, as rapidly as envisaged earlier, during 2013-2014. In this view, RBI notes that ‘the headroom for further monetary easing remains quite limited’.

Governor Subbarao in a recent speech had emphasised that monetary policy is the first line of defence to guard against inflation getting generalised through ‘unhinged inflation expectations’. He favours inflation to be ideally in the 4-6 per cent range. The 2013-2014 Monetary and Credit Policy to be unveiled by RBI governor on 3 May is expected to elaborate on the likely contingencies that could arise in the coming fiscal year as well as set indicative growth, inflation and monetary aggregates. (IPA)
Next Story
Share it