Is the RBI waiting for the impossible to happen?

The bottom line of the mid-term policy review is that policy rates of the repo will be reduced, but the timing will depend on the government.

The RBI has been voicing its discomfort on the government’s fiscal and subsidy policy and has been urging the government to get its act together before it cuts interest rates. The question here is, will this government ever act? Is the RBI waiting for the impossible?

The Rail Budget fiasco, where the Railways Minister was forced to resign for prudent rail policies, is a precursor of things to come. The government is in no position to act prudently and the RBI will be waiting forever if it wants to take monetary steps to boost economic growth.

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The RBI has to act independently of the government, and if it means hiking or reducing rates in the face of inflation and growth expectations, it has to make its move and not wait for the government. Government policies will impact policy transmission and should not impact the policy itself.

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The RBI maintained status quo on policy rates in its mid-quarter policy review on Thursday. The policy document talks about the fact that inflation is moderating but there is suppressed inflation in food, fuel and fertilisers due to administered prices. The oil price rise of around 15 percent (brent crude) since the start of 2012 has also played a part in the RBI refraining from reducing the repo rate.

The central bank had cut the CRR (cash reserve ratio) by 75 basis points last week to ease financial year-end liquidity pressures. The central bank probably felt that the higher than expected CRR cut (the market was expecting a 50 basis point cut) was enough for now, and it will wait for the government to show a committed fiscal consolidation plan before reducing policy rates.

Inflation, according to the RBI, has moderated with non-food manufacturing inflation down from 7.9 percent in December 2011 to 5.8 percent in February 2012. The fall in non-oil commodity prices is attributed to the fall in manufacturing inflation.

The RBI has also mentioned that the momentum indicator of non- oil inflation (seasonally adjusted three-month moving average inflation) is moderating.

The RBI expects GDP growth for fiscal 2011-12 at 6.9 percent against its previous estimate of 8 percent.

The central bank has spelt out that while sales are keeping up for corporates, there is increased pressure on margins, indicating that companies are unable to fully pass on higher costs into the economy.

The central bank has achieved its target of below 7 percent inflation for fiscal 2011-12, but it has come at the cost of GDP growth.

It will issue its own estimates for growth and inflation for 2012-13 in its April review.

If the government does not bring out a good Union Budget with proposals to cut subsidies and deficits, interest rates may stay where they are and will further lower growth estimates for 2012-13.

On the face of it, it looks like wishful thinking that this government will turn reformist to please the RBI. On the other hand, the government might pile on political pressure on the RBI to cut rates – and that is worse.

Arjun Parthasarathy is the editor of www.investorsareidiots.com, a web site for investors.