Once bitten, twice shy: Subbu is telling Chidu, 'pehle aap'

So Dr Duvvuri Subbarao, the Reserve Bank of India (RBI) Governor, has done it again: he has held firm on rate signals, but has acknowledged the small effort made by the finance minister in moving towards fiscal consolidation with nice words and a small pat on the back. But no gung-ho praise and enthusiastic opening up of the monetary tap.

This is the net takeout from his mid-quarter monetary policy statement today, where he has cut the cash reserve ratio by 0.25 percent (25 basis points) to 4.5 percent, but refused to reduce the signalling rate, the repo, which is the rate at which banks borrow overnight money from the central bank.

The CRR cut (effective 22 September) will unleash funds of Rs 17,000 crore - which, over a year, could expand overall liquidity four times as much, by around Rs 65,000-70,000 crore.

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So what has he achieved with this stratagem of easing money, but not signalling easy money? Is he trying to speak with a forked tongue?

Subbarao is actually sending out several messages.

[caption id=“attachment_458143” align=“alignleft” width=“380”]  Subbarao does not want to be seen as a party pooper when the government is finally moving on fiscal consolidation with its Big Bang reforms and diesel price hike. Hence the CRR cut. PTI[/caption]

First, he does not want to be seen as a party pooper when the government is finally moving on fiscal consolidation with its Big Bang reforms and diesel price hike. Hence the CRR cut. But this cut is really a recognition of the coming liquidity crunch, as advance tax payments (due last Saturday, 15 September) drain out money from the system and the traditional festive season surge in demand for credit looms. The primary message is we will help ease liquidity - as always.

Subbarao said as much: “Going forward, the wedge between deposit growth and credit growth could widen on the back of the seasonal pick-up in credit demand in the second half of the year. This, combined with outflows on account of advance tax payments and the onset of festival-related currency demand, could accentuate pressures on liquidity over the next few weeks. In these conditions, appropriate liquidity management assumes importance…”. P Chidambaram should thus tell Subbarao, “thanks but no thanks.” Subbarao may have done it anyway.

Second, Subbarao is telling the government that inflation is not quite licked and hence there is no case for launching a cheap money party. He said: “Core inflation pressures remained firm with non-food manufactured products inflation inching up from 5.1 per cent in April to 5.6 percent in August and the momentum indicator remaining elevated. Even as demand pressures moderate, supply constraints and rupee depreciation are imparting pressures on prices, rendering them sticky.” And this is true for the consumer price index, too. “Notwithstanding some easing in July, core CPI inflation (CPI excluding food and fuel sub-group) remains elevated”.

Third, Subbarao is saying Big Bang Friday was no big deal. He is indirectly saying that what the government did last Friday (FDI, diesel hike, etc) was not really cause for monetary action, since the RBI had already done its bit in April. He said: “In April, the Reserve Bank implemented a frontloaded policy rate reduction of 50 basis points (0.5 percent) on the expectations of fiscal policy support for inflation management alongside supply-side initiatives for addressing the deceleration of investment and growth. As these expectations did not materialise and inflation remained firmly above 7.5 percent, the Reserve Bank decided to pause in its policy easing in the Mid-Quarter Review (MQR) of June and in the First Quarter Review (FQR) of July.”

In short, the governor is saying that he has delivered, and what the government announced on Big Bang Friday was what should have come much earlier.

Fourth, the RBI is clearly willing to say nice things, but will stop short of action. The policy statement thus lauded the diesel price hike and the “rationalisation” of subsidies for LPG as “a significant achievement” but pointed out that the short-term impact will still be inflationary. It is unwilling to go beyond words and could not resist pointing out again that the government did not do what was promised earlier. “It is important to note that these (diesel price) revisions were anticipated at the time of the April policy when a front-loaded repo rate reduction was undertaken.” Subbarao went on to underscore that the government should do more: “Over the longer run, holding down subsidies to under 2 percent of GDP, as indicated in the Union Budget for 2012-13, is crucial to manage demand-side pressures on inflation.

Fifth, as far as interest rates go, the RBI knows that a CRR cut - preceded earlier by deposit rate cuts by major banks - will anyway ease up rates. But the CRR cut will help banks more than borrowers.

The Governor concluded with this homily: “Mitigating the growth risks and taking the economy to a higher sustainable growth trajectory requires concerted policy action across a range of domains, a process to which last week’s actions made a significant contribution. Monetary policy also has an important role in supporting the growth revival. However, in the current situation, persistent inflationary pressures alongside risks emerging from twin deficits - current account deficit and fiscal deficit - constrain a stronger response of monetary policy to growth risks.”

This is the underlying message: “It’s good to see some action now. If only it had come earlier, when it was promised. Anyway, keep up the good work, and we could help. But we did our bit last April when you didn’t keep your promises. So this time we will say “pehle aap”, and act after you do your job consistently.”

Smart Subbu, real smart.