RBI lobs ball to Pranab PDF Print E-mail
Wednesday, 25 January 2012 00:00
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Can’t cut policy rates till fiscal deficit gets in control

Concerns over the sustainability of the sovereign debt problem in the eurozone have increased, India’s growth has deteriorated because investment activity has decelerated sharply, non-food credit growth has decelerated from 21.3% at end-March to 15.7% by end-December … All of these are statements contained in RBI Governor Duvvuri Subbarao’s monetary policy statement, and yet he chose to do precious little. Sure, the CRR has been cut by 50 bps but the CRR does not signal a shift in monetary policy stance, it merely seeks to restore some liquidity (R32,000 crore) that has been sucked out of the market by the government borrowing an extra R90,000 crore to meet the needs of a runaway fiscal deficit. Indeed, with private sector borrowing down dramatically, it’s likely the funds released from the CRR cut will just find their way back into government securities.

So why didn’t Subbarao begin to cut policy rates especially since all forecasts are for a considerable softening in non-oil commodity prices at the global level. One, as the RBI Governor has said, the

rupee’s depreciation has negated the benefits of lower global

commodity prices. Two, there is repressed inflation since petrol/ diesel/kerosene/LPG prices can be hiked any time (public sector oil firms are losing R1.4 lakh crore on this in a year). Three, as the Governor’s statement makes clear, the fiscal deficit will overshoot the target dramatically for this year and “slippage in the fiscal deficit has been adding to inflationary pressures and it continues to be a risk for inflation.”

In other words, even though the fall in inflation over recent months looks larger than it is because of seasonal factors, the RBI Governor is saying he can’t take a chance—if the deficit in FY13 is equally large, and the Food Security Bill could ensure it is significantly higher, what is RBI to do then? Tuesday’s monetary policy has lobbed the growth ball back in the finance minister’s court—the earliest any cut in policy rates can be expected is after the budget. In various places in the statement, RBI has made it clear high interest rates are just one of several factors affecting investment—there’s the global environment, unhealthy fisc and “policy and administrative uncertainty” that’s also at work. Unless these are addressed by “policy actions”, RBI says, “a continuing decline in investment will push the economy’s trend rate of growth down, further aggravating inflationary pressures and threatening external and internal stability.” Subbarao’s critics will argue a rate cut would stimulate growth and thereby take care of several of the issues by, for instance, encouraging FDI/FII inflows. The question the RBI Governor has implicitly posed—is investment being held back by unfriendly government policy or by high interest rates—doesn’t really need answering.



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