The second stimulus package announced by the government and another round of rate cuts by RBI are steps in the right direction and will help ease the pain India will face in 2009. Since the crisis arose out of a crisis in finance, the focus is, quite appropriately, on opening up channels for access to finance. Fiscal space is limited, as seen in the Rs 20,000 crore package that amounts to less than half a per cent of GDP. Removing interest rate ceilings for external commercial borrowings (ECB), increasing caps on FII investment in bonds, easing of restrictions on borrowing for real estate, reducing the repo, reverse repo and the CRR will increase the availability and lower the cost of credit for companies. However, while these measures will help, they may not be sufficient to contain the slowdown. While there is little scope for further fiscal action in the current fiscal year, there is need for action on at least three fronts. These include further cutting interest rates, immediate steps to develop the bond-currency-derivatives (BCD) nexus and further removal of capital controls. Though the government has said that it does not envisage any further measures in the current fiscal year, measures such as these which do not impact the fisc can and should be immediately implemented.

First, there is a case for RBI to cut rates even further. RBI can go all the way to a zero short-term interest rate, as some other central banks have done. To understand the case for cutting rates let’s focus on the real rate — the short-term policy rate minus the expected inflation rate. What do current trends show? WPI inflation, based on point-on-point calculations using seasonally adjusted data, was above 8 per cent (annualised) for each month from November 2007 till July 2008 which was a high inflation environment. But in September, WPI inflation was about 0, and in October it was -7.4 per cent, on an annualised basis.

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