RBI holds policy rates: Central bank is caught in a tight spot to balance growth and inflation worries

The Reserve Bank of India, RBI, seems to have given a thumbs up to the Union Budget calling the measures announced will provide an impetus to growth. It thinks the Budget’s emphasis to boost the rural economy and infrastructure should help the growth momentum in the near-term; the corporate tax rate cuts of September 2019 should help boost the growth potential over the medium-term. But, what the policy doesn’t say is that as a percentage of the Gross Domestic Product (GDP), the total Budget expenditure is just 0.3 percent higher than the last year. The government pegged total expenditure for FY21 at Rs 30.42 lakh crore or 13.5 percent of GDP compared with a total expenditure of Rs 26.99 lakh crore (revised estimate) or 13.2 percent of GDP in FY20. That’s just 0.3 percent increase over a year; not what a sinking economy needs. The Budget announced by Finance Minister Nirmala Sitharaman was a lost opportunity to revive the demand scenario. Except for a push on affordable housing and a complicated personal tax cut, there was no special focus on reviving consumer demand in rural India or a big spending push to kickstart the slowed growth engines. On the growth front, the RBI had to send a signal that it is on the side of the growth lobby. But, on the other side, the inflation threat is looming above its comfort level. A growth supportive policy requires slashing rates. And if you want to check inflation, policy rates must harden. Any rate action on either side could damage the other. What does the central bank do? The RBI safely chose the middle-path. It didn’t do anything on rates for now but said that the policy stance remains ‘accommodative’. [caption id=“attachment_5766671” align=“alignleft” width=“380”]  File image of RBI governor Shaktikanta Das. Reuters[/caption] “The MPC also decided to continue with the accommodative stance as long as it is necessary to revive growth while ensuring that inflation remains within the target,” the RBI said announcing the rate decision. There is no surprise in this decision and that’s what the markets expected too. Markets didn’t move much. The Rupee traded flat and bond yields remained in a range. The benchmark 10-yr yield fell to 6.47 percent from 6.51 percent. The RBI’s pro-growth comments have kept the hopes of a rate cut, maybe later this year, alive in the markets. “The MPC recognises that there is policy space available for future action,” the RBI statement said. The overall tone in the policy suggests that the RBI is clearly worried about the growth situation. “Economic activity remains subdued and the few indicators that have moved up recently are yet to gain traction in a more broad-based manner,” it said. On the other hand, inflation worries are looming. The retail inflation, in December, touched a 65-month high of 7.35 percent rising above the comfort level of the central bank. The growth for FY21 is projected at 6 percent, and for the current year at 5 percent. It expects retail inflation to stay elevated in the near term and ease later assuming a good monsoon. The RBI’s promise of future rate cuts is purely based on its assumption that inflation will ease going ahead. But much will depend on a good monsoon. If these assumptions go wrong and inflation stays high, the central bank will be forced to on-hold mode for a prolonged time. The message from the policy is clear. The RBI wants to join the government in supporting economic growth. Just that, high inflation doesn’t permit it to do so. The RBI is caught between a rock and a hard place.