Reserve Bank of India (RBI) governor Duvvuri Subbarao’s ability to surprise is getting better. RBI’s move to keep key rates unchanged at its mid-quarter policy review despite the growing clamour and pressure from the finance ministry to cut rates demonstrates once again that the governor intends to stick to his assessment of the economic realities and wait and watch for now.
While the hopes of the markets were dashed quickly and the BSE Sensex plunged sharply at the dot of 11 am when RBI unveiled its status quo policy review, it must be said that Subbarao’s policy statement is a prudent one and shows that the central bank, in the absence of any policy initiatives from a paralysed central government, is not willing to stick its neck out and take risks just to keep markets and the corporate sector satisfied. And the policy statement gives enough reasons why it has not chosen to cut rates this time, despite several economists and policywatchers betting on a 25 basis points repo rate cut and some even hoping it would add another 25 bps cut in the cash reserve ratio (CRR) to ease liquidity.
In fact, the RBI statement does not mince its words, and says its assumptions for the 50 bps cut in April have not come about and another rate cut at this juncture could be risky. Says RBI in the statement: “The Reserve Bank had frontloaded the policy rate reduction in April with a cut of 50 basis points. This decision was based on the premise that the process of fiscal consolidation critical for inflation management would get under way, along with other supply-side initiatives. Our assessment of the current growth-inflation dynamic is that there are several factors responsible for the slowdown in activity, particularly in investment, with the role of interest rates being relatively small. Consequently, further reduction in the policy interest rate at this juncture, rather than supporting growth, could exacerbate inflationary pressures.”
In fact, Subbarao goes about countering several of the assumptions which analysts have been putting forward to justify a rate cut: the reduction in core inflation, the easing of oil prices etc. RBI says the reduction in crude oil prices and its impact on wholesale prices have been “significantly offset” by the depreciation in the rupee. Besides, “even at the current lower level of global crude oil prices, significant under-recoveries persist in respect of administered petroleum product prices.” Obviously, Subbarao is not amused at the government’s continuing inability to bite the politically sensitive bullet of increasing prices of other fuels to reduce under-recoveries and embark on constructive fiscal consolidation.
The RBI governor, who has not hesitated on earlier occasions to make it clear that this rate actions are contingent upon the government doing its bit on easing supply constraints, underscores that point once again this time. “Notwithstanding the moderation in core inflation, the persistence of overall inflation both at the wholesale and retail levels, in the face of significant growth slowdown, points to serious supply bottlenecks and sticky inflation expectations,” the policy statement says.
The consequent subsidy burden on account of oil is crowding out public investment when reviving public and private investment is a “critical imperative.” “The widening current account deficit (CAD), despite the slowdown in growth, is symptomatic of demand-supply imbalances and a pointer to the urgent need to resolve the supply bottlenecks.”
Subbarao has also not hesitated in debunking popular perception in the corporate sector that growth has taken a hit owing to high interest rates. Says RBI: “In this context, it is relevant to assess as to what extent high interest rates are affecting economic growth. Estimates suggest that real effective bank lending interest rates, though positive, remain comparatively lower than the levels seen during the high growth phase of 2003-08. This suggests that factors other than interest rates are contributing more significantly to the growth slowdown.” Clear enough hint for both the government and the corporate sector that they are barking up the wrong tree and RBI can only do this much and no further at this point.
However, recognizing the need for some action to demonstrate its concern for flagging growth, the central bank has promised to continue using open market operations (OMO) as and when warranted, to contain liquidity pressures, a significant promise which should please the markets to some extent. It has also reiterated that it stands committed to using all available instruments at its disposal to respond “rapidly and appropriately” to any adverse developments.
For now, however, RBI has made it clear that it wants to have enough comfort before moving once again on a rate reduction. The central bank reckons there will be another round of quantitative easing by central banks in Europe and the US which could lead to a rebound in commodity prices and lead to shocks for India and other oil importers. This has clearly weighed on the minds of Subbarao and his colleagues at Mint Road.
While Greece continues to weigh heavily on the global economy despite Sunday’s election results providing somewhat of a breather, there are several factors to watch for India’s central bank: stickiness in inflation, the government’s inability to act on fuel prices other than petrol, the policy paralysis at the Centre and the absence of any clear big-ticket reform measures. In such a scenario, Subbarao’s message is this: I’ve done my bit in April and won’t risk more right now.
After all, as the political establishment gets busy with the Presidential elections, finance minister Pranab Mukherjee shows his eagerness to hang up his boots and get into Rashtrapati Bhavan, and there’s a good degree of uncertainty in economic policymaking from New Delhi, Subbarao, the prudent central banker, is unwilling to play to the corporate galleries. Mint Road isn’t budging. Not just yet.