RBI’s middle game

That rates remain unchanged could indicate it was given no clear political message

The Reserve Bank of India has decided that data on growth slowdown is still mixed but that on inflation is clear with prices still raging high and so it has prescribed a standstill on rates. Monday morning's treatment sent the stock market reeling with investors correctly anticipating that the prevailing high rates will pull down sales of automobiles and consumer durables too, about the only two sectors holding up demand when all others, including capital goods and intermediates, have shrunk. What worried the market was not the status quo but a hawkish stance on inflation in the mid-quarter monetary policy review that augurs minimal change for July too.

On a day when Fitch too moved India's outlook to negative from stable, the RBI's basket of concerns seems misplaced. The bank has argued that growth slowdown is not primarily due to high interest rates, a point well taken. It has also argued that a 50 basis point rate cut in April was made expecting a corresponding response from the fiscal policy to arrest inflation, like a cut in subsidies, which has not happened.

There is no doubt that fiscal adjustments in the economy have not yet begun. For instance, the rise in petrol price has been marginal for the rest of the economy. There is also no doubt that depreciation in the value of the rupee has provided some relief to sectors like exports and Monday's increase in the limit of export credit refinance from 15 per cent of outstanding with banks to 50 per cent can potentially release additional liquidity of over Rs 30,000 crore, a sort of limited cut in cash reserve ratio. But the big question is: which evil do policy planners need to chase now? A decline in the GDP growth rate from 9.2 per cent from the fourth quarter of 2010-11 to 5.3 per cent in the corresponding quarter of 2011-12, is a colossal slowdown. The bad news from the mineral sector, the capital goods sector and the advance tax data for the first months of the new fiscal shows the pain is likely to intensify. True stagflation is one of the most difficult challenges faced in macroeconomic policy-making but it is not clear if further flight of capital and rising gold imports putting an even greater pressure on the rupee can be counter-balanced only through inflation management. It is possible the RBI is waiting for cues from the new team in the finance ministry. Hopefully, the transmission mechanism of signals works fast enough for Governor Subbarao to, if needed, reverse position.

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