Subbu's subtext: Don't believe in FM or rate cut, but what to do?

Will the real Duvvuri Subbarao please stand up?

The Reserve Bank’s Annual Monetary Policy statement for 2012-13, which unexpectedly cut the repo rate not by 0.25 percent (25 basis points) but by a heftier 0.5 percent, suggests that Subbarao, the inflation hawk, has metamorphosed into Subbu, the growth dove.

But the makeover is unconvincing. Reading between the lines of Tuesday’s policy statement, and the previous day’s macroeconomic review by the Reserve Bank, it seems that Governor Subbarao is unconvinced about the possibility of a genuine moderation in inflation, but has instead persuaded himself to believe that his real problem is to prevent an unwholesome crash in growth.

In fact, his statement suggests that he can no longer resist political pressure to reduce rates, and is hoping that slowing growth will help him bring inflation down. He has left the job of tackling inflation to god and a slowing economy.

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However, he appears to be a hawk in dove’s clothing since he has also signalled that he may not cut rates regularly this year.

This is the policy’s most crucial statement: “The reduction in the repo rate is based on an assessment of growth having slowed below its post-crisis trend rate which, in turn, is contributing to a moderation in core inflation. However, it must be emphasised that the deviation of growth from its trend is modest. At the same time, upside risks to inflation persist. These considerations inherently limit the space for further reduction in policy rates.”

[caption id=“attachment_278240” align=“alignleft” width=“380” caption=“Reading between the lines of Tuesday’s policy statement, the Reserve Bank, it seems that Governor Subbarao is unconvinced about the possibility of a genuine moderation in inflation.”]  [/caption]

Translated, the meaning is clear: inflation isn’t over. It may be coming down because growth is slowing. But growth is not slowing fast enough to really bring inflation down. So don’t expect me to keep bringing rates down just because life is difficult for corporate with high rates.

In fact, Subbarao’s unconvincing donning of the dove’s garb was evident in Monday’s statement itself, when the Reserve Bank more or less made the point that inflation is “sticky”, that there is a large “suppressed inflation” due to inadequate pass-throughs of energy subsidies, that food inflation is back as the “transitory effects” have waned, and that wage pressures in both “rural and urban areas are yet to soften.”

From this assessment, one would have expected Subbarao to stay his course and not cut rates, or, at best, reduce it by a token 25 basis points.

But he gave us a clue that he is bowing to pressure in his last statement of Monday. “Inflation expectations moderated in Q4 of 2012-13 but remain high. With significant upside risks to inflation, monetary policy needs to keep them anchored, while shifting the balance of policy to arrest the deceleration in growth momentum.”

This can only mean that he has bowed to political and corporate pressure for now to ease growth concerns, but he cannot really be expected to keep doing this when inflation is not showing any real signs of long-term abatement.

His Tuesday statement indicates why Subbarao remains an unconvincing dove on inflation.

He said: “Domestically, the state of the economy is a matter of growing concern. Though inflation has moderated in recent months, it remains sticky and above the tolerance level, even as growth has slowed. Significantly, these trends are occurring in a situation in which concerns over the fiscal deficit, the current account deficit and deteriorating asset quality loom large. In this context, the challenge for monetary policy is to maintain its vigil on controlling inflation while being sensitive to risks to growth and other vulnerabilities.”

“Sensitive to risks” can mean one of two things: worries over growth, and politicians’ concerns about high rates.

But will Subbarao remain equally “sensitive” to such risks in future? The chances are as long as GDP growth looks like staying below 7 percent, he will be a dove. If growth rises above 7 percent, he will not cut rates eagerly.

Subbarao may also be quietly offering Finance Minister Pranab Mukherjee a simple bargain: Focus on fiscal consolidation and I might deliver better rate cuts.

He obviously believes that the recent budget did not deliver enough - at least not yet. He said: “Even though the Union budget envisages a reduction in the fiscal deficit in 2012-13, several upside risks to the budgeted fiscal deficit remain. In particular, containment of non-plan expenditure within the budget estimates for 2012-13 is contingent upon the government’s ability to adhere to its commitment of capping subsidies. Going by the recent burden-sharing arrangements with the oil marketing companies (OMCs), the budget estimate of compensation for under-recoveries of OMCs at the present level of international crude prices is likely to fall significantly short of the required amount. Any slippage in the fiscal deficit will have implications for inflation.”

Put bluntly, Subbarao is telling Mukherjee: “I won’t believe your budget numbers till it is followed by action.”

Is Governor Subbarao also saying that if the FM fails, he will have to abandon even his spurious dove-ishness on rates - as visible in the Annual Policy statement?

The jury is out. But macroeconomically this is clear. If demand is not brought down by reducing subsidies (diesel, fertiliser, etc) and administered energy price hikes, Subbarao may have to do with by abandoning rate cuts in 2012.

The subtext is this: “I am doing more than my bit to help you. Now do yours diligently, or else…”