Few can fault RBI for not cutting the CRR along with the 25 bps cut in the repo since, while liquidity increases are important for ensuring the rate cuts get passed along to eventual borrowers, the central bank has likely taken the view this will get fixed once the government gets back to spending come April 1. And till then, RBI will infuse liquidity through open market operations. RBI is right when it points to critical role of government in clearing projects and sticking to its fiscal commitments—more so since oil PSUs have missed one diesel price hike deadline and the government has just introduced the food security bill. Though RBI couldn't have possibly anticipated it, DMK's pullout threat shows the policy environment remains fragile. Indeed, while RBI has cut repo by 75 bps over the last year and CRR by 200 bps—also, corporate bond yields are also lower than a year ago by 75-100 bps—there is little evidence this has spurred investment. In other words, most growth levers remain with the government, though only the naïve will believe interest rates have no role in spurring investments.
The problem with RBI policy, however, is the wild swings in its tone. In January, when RBI cut both repo and CRR, December's retail inflation was a high 10.6%—while that didn't stop RBI from cutting rates and it did talk of CPI being a concern, it never spoke, as it did on Tuesday, of the wedge between WPI and CPI ‘exacerbating the challenge for monetary management in anchoring inflationary expectations’. Indeed, the deceleration of services growth 'to its slowest pace in a decade', which RBI bemoaned on Tuesday, is a good thing since, as in the case of slowing manufacturing GDP and falling manufacturing WPI inflation, this is what will drive down core ex-fuel and ex-food CPI over the next quarter or two. The current account deficit (CAD), RBI said on Tuesday, was a key concern—in January, it lowered rates despite citing this as a 'constraint on monetary easing'. What makes the picture even more confusing is speeches by RBI Governor D Subbarao over the last fortnight. On March 8, he spoke of high inflation not being the new normal arguing the wage-price spiral was self-limiting since government no longer had the fiscal capacity to spend on welfare programmes in a big way. As for higher global energy prices that worried the central bank on Tuesday, the Governor then spoke of the impact of the shale revolution and of how 'for over a century now, commodity prices have been prone to mean revision'. On March 13, the Governor debunked the view that rate cuts will worsen the CAD—cutting rates, he said, was unlikely to translate into import demand when growth was sluggish and FII flows would be encouraged by 'a signal of lower inflation and better investment environment'.
RBI is entitled to its view on whether rate/CRR cuts are warranted by the facts on the ground, but since the first rule of central banking is not to surprise the market, the central bank needs to be consistent in its tone. It can't bring in CPI, CAD and even the output gap as key variables in certain policy statements, omit them in others, and then bring them back again.