Finally, Finance Minister Palaniappan Chidambaram can afford a smile. The Reserve Bank of India’s decision to reduce the benchmark repo rate – the rate at which the RBI lend short-term funds to banks – by 25 basis points would certainly be good news for a finance minister battling heavy odds in steering a sputtering economy back on the growth path.
Oscillating between disappointment and hope, Chidambaram had been waiting for RBI Governor Duvvuri Subbarao to do his bit to bring back the growth momentum through the monetary policy. But Subbarao, sticking by the book, had stoutly refused to do so, waiting instead for clear policy pronouncements from New Delhi that it was serious about fiscal consolidation.
However, on 29 January, Subbarao did oblige the FM with a 25 basis point rate cut, and added a bonus by way of another 25 basis points cut in the cash reserve ratio to infuse more liquidity into the system for productive lending. The CRR cut would release Rs 18,000 crore into the banking system. This is the first repo rate cut Subbarao has effected in nine months as corporate India and New Delhi waited with bated breath for the central bank to act to spur a slowing economy. The repo rate now stands at 7.75 percent, and CRR at 4 percent.
Tuesday’s rate action was, by most accounts, expected and factored in by the markets, since the RBI had hinted earlier that monetary easing could begin from January as growth took a serious beating. What the central bank was clearly waiting for was inflationary pressures to ease, so that the growth-inflation dynamic would tilt in favour of aiding growth rather than taming inflation. That seems to have happened – at least by RBI’s own assessment – warranting a rate cut after many months.
But true to Subbarao’s nature of keeping the markets guessing, the RBI did provide some moments of suspense just a day ahead of the policy when it said in its monetary policy review that the scope for monetary policy action was ‘constrained’ given ‘the preponderance of non-monetary factors behind the current slowdown in an environment where risks from high inflation, current account and fiscal deficits still remain..”
In fact, till now, RBI had opted to cut CRR rather than the repo rate as a signal that it was keen to give a push to productive investments. In fact, recognising that growth was under serious threat, RBI also reduced its growth estimate from the 5.8 percent given in the second quarter review to 5.5 percent now. In line with trends, it also lowered its inflation target to 6.8 percent from 7.5 percent set out in the earlier policy.
The fact that the growth-inflation dynamic has tilted is amply evident from Subbarao’s policy statement this time. The policy says the stance is intended to
•provide an appropriate interest rate environment to support growth as inflation risks moderate;
•contain inflation and anchor inflation expectations; and
•continue to manage liquidity to ensure adequate flow of credit to the productive sectors of the economy.
Evidently, the priority for the RBI has now shifted to providing an environment which would support growth. This, however, has been facilitated by inflation receding somewhat to manageable levels. Says RBI: “Headline WPI inflation and its momentum edged down in November-December on the back of softening of non-food manufactured products inflation, even though food inflation has risen, adversely impacting households’ inflation expectations. The staggered increase in diesel prices announced earlier this month will percolate through to overall costs and inflation; however, these price pressures will dissipate over time, and the consequent reduction entailed in the fiscal deficit will bring about an enduring reduction in inflation and inflation expectations.”
Mindful that this too can change quickly, RBI adds that “it is critical that even as the monetary policy stance shifts further towards mitigating growth risks, the objective of containing inflation and anchoring inflation expectations is not de-emphasised.”
Whatever the caveats, RBI’s twin action of reducing the policy rate and CRR will make both the markets and corporate India happy. The 30-share BSE Sensex has ruled strong since the policy was announced, well above the 20,100 mark and boardroom bosses will surely give Subbarao a clear thumbs-up this time round. RBI’s guidance too will bring cheer to those waiting for a monetary policy push to growth.
Says RBI in its policy guidance: “With headline inflation likely to have peaked and non-food manufactured products inflation declining steadily over the last few months, there is an increasing likelihood of inflation remaining range-bound around current levels going into 2013-14. This provides space, albeit limited, for monetary policy to give greater emphasis to growth risks. The above policy guidance will, however, be conditioned by the evolving growth-inflation dynamic and the management of risks from twin deficits.”
From the signals emanating from Mint Road, it is evident that the finance minister’s attempts at fiscal consolidation and reform have been seen as genuine by RBI. Genuine enough, given the political constraints faced by New Delhi and the fact that growth has been seriously faltering, heading to its slowest in 10 years. The latest policy action from Subbarao is indication to the finance minister that the RBI governor just joined him in his journey of bringing the economy back on track. Chidambaram is not walking alone anymore.