The Subbarao Dilemma: To cut or not to cut

The Reserve Bank of India governor Duvvuri Subbarao is in an unenviable position. He is caught in a cleft-stick between a mounting demand from corporate India and the finance ministry to reduce interest rates, even as the overall macroeconomic indicators and inflationary trends do not give RBI any comfort.

The RBI will announce its keenly-awaited Annual Policy for FY13 on 17 April.

A day before Subbarao is to announce the policy, the latest inflation figures came in at 6.89 percent for March, against 6.95 percent the previous month. The WPI print will not be good news for the RBI, which has been attempting to keep inflationary expectations under control over the past several quarters, in the process effecting monetary tightening of about 525 basis points, by way of 13 rate hikes.

Only now, RBI is on pause mode, and there were expectations that since growth is sputtering, RBI may be forced to start its monetary easing cycle by reducing rates by about 25 basis points. To address the specific problem of liquidity, RBI had effected a deep 75 basis points cut in the cash reserve ratio (CRR) on 9 March, just a week before the Union Budget.

The Economic Times, in its lead story on Monday, a day before the policy announcement, called the present situation Subbarao’s “biggest challenge” saying that while there are enough reasons for RBI to maintain status quo on interest rates, there is a “growing clamour for rate cuts from industry and finance ministry officials.”

The RBI, most analysts now feel, is caught between a rock and a hard place. If it keeps interest rates where they are, growth will take a further beating. Already, growth slipped to 6.1 percent in the final three months of 2011, showing that the successive rate hikes and the tough economic and investment climate had already begun taking its toll on the economy. The growth figure was the lowest recorded in the past three years.

The Index of Industrial Production (IIP) figure, which came in last week, also showed a mere 4.1 percent growth for February 2012, which was below analysts’ expectations. What was worse, a huge statistical error led to a major downward revision of the January IIP figure from 6.8 percent to just 1.1 percent. While the Central Statistical Organisation (CSO) attributed it to misreporting of sugar figures, finance minister Pranab Mukherjee called it ‘baffling’. Whatever the situation, the fact that industrial activity has taken a serious hit is for all to see. This makes Subbarao’s dilemma even more severe.

In its comments immediately after the latest WPI figures came out, Citi India pointed out that the fuel index moderated further to 10.4 percent from 12.8 percent in the previous month - primarily due to

coal. “However, revision in tariffs coupled with measures to address ‘suppressed’ inflation could result in a firming up in prices. Thanks to the base effect, manufactured products continued to edge lower to 4.9 percent v/s 5.7 percent last month. On a cumulative basis,

FY12 ended with WPI averaging 8.8 percent v/s 9.6 percent in FY11,” Citi said.

Analysts are now expecting the extent of monetary easing to be limited. “Going forward, given the base effect, we expect inflation to average 7.4 percent in FY13 thus limiting the extent of monetary easing to 50-75bps for FY13,” said Rohini Malkani of Citi.

The problem, most policy watchers agree, is that despite this multitude of factors, Subbarao will be under tremendous pressure to do something to bring back the growth momentum somewhat. More so, since Budget 2012 did little of any consequence on that count, bringing the load entirely back on the RBI governor’s shoulders. With industrial investment taking a hit and the common man joining in the chorus of reducing rates, the RBI is faced with a major challenge this time round.

“Given that headline inflation has eased from 9 percent plus levels

seen earlier, there is now need for policy measures to bring growth back to about 7 percent levels,” argued Malkani. “Given the intractable fiscal deficit, the difficult political environment, the onus unfortunately is back on monetary policy. We thus maintain our view of the RBI commencing its easing cycle by cutting rates by 25bps in its policy tomorrow. The outlook for policy rates post easing of 50bps would be data/event dependent.”

Even if Subbarao does oblige, chances are the rate cut will, from RBI’s side, be more of a statement of intent and goodwill, and little else. From Subbarao’s perspective, enough challenges and threats still remain in the economy before he can be convinced that the monetary easing cycle must begin. But for now, even a 25 bps cut will work wonders for a corporate sector waiting for some signals and a battle-scarred North Block which has been sending not-so-subtle messages to RBI for months.