The tyranny of the status quo?
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RBI has probably done the appropriate thing in maintaining a status quo given that it has pursued its anti-inflationary stance for the last two-and-a-quarter years, with only one aberration in April 2012. Few expected any change, and hence it was not a surprise. Three significant thoughts come up here.
The first relates to the stance on interest rates and what it means to us given that inflation will be the anchor for future policy decisions too. While food and fuel inflation are clearly out of RBI's domain, it has spoken a bit on core inflation, which is around 5% currently and susceptible to volatile influences from global disturbances. So what are we to make of it? One, the RBI is not talking of any transmission mechanism as such, since this stance will not lower inflation. Second, it has real interest rates in mind, which appear to be low today given that at an 8% repo rate, borrowers are actually getting away with a lower real interest rate. Third, while one can keep expecting RBI to lower rates before every policy, and debate and conjecture the same, it actually should not be doing so until inflation is within its range. And that range has gone up now to 7%, and with a possibility of a drought, food inflation will continue to be in the double digit range.
The second thought is that growth will be lower this year, at 6.5%, which sounds reasonable enough. For the first time, RBI has given this signal early and has not waited till December to lower its forecast. The gloomy monsoon and lackluster industrial performance so far does warrant a step down from 7.3%. The internals are still hard to fathom as nil growth in agriculture and moderate 3-4% growth in industry will require the service sector to do remarkably well to move to this mark. But yet, RBI does not think that lowering interest rates will help growth in any way, as its own studies have shown that interest costs have not choked growth in the past. It is the overall demand conditions that have to change for something to happen. Here, RBI is silent on how we are to change this situation. It has, in fact, asked the government to do its bit.
Third, inflation is now expected to be higher, and on a point-to-point basis would be 7% by March. This again appears realistic with possibilities of further upward revisions in the coming months. The monsoon failure means high food prices on top of higher MSPs, which have already lent an upward bias. Fuel price revisions mean upward pressure on prices—this is what RBI has spoken of as part of fiscal consolidation. This means any such act will only impinge on inflation and reinforce RBI's posture on interest rates. To top it all, the rupee is volatile, and with the possibility of a revival in commodity prices globally, the so-called core inflation will continue to keep the pressure up. Hence, the chances of interest rates being reduced on account of inflation coming down become progressively remote.
RBI has sought to placate the markets by providing sops through the liquidity route. The cut in SLR, however, is more of a misnomer. Banks today hold on to 28% SLR and hence bringing it down from 24% to 23% does not affect the system's liquidity given that this excess SLR of 4% has been voluntarily maintained by banks. Banks hold on to excess SLR either as a buffer that provides leeway for credit expansion or as a part of their own strategy to maintain the quality of their portfolio. At the margin, those with 24% SLR would benefit by getting these funds. Otherwise, this move is quite neutral in its impact and this reduction should be seen more as a conciliatory move by RBI to help banks without giving much away. RBI has anyway been active in the OMO segment, providing liquidity to banks, and hence this 1% reduction is largely symbolic. Besides, liquidity is not a major issue today given the dynamics of funds flow in banks.
Under these conditions, maintaining the status quo sounds logical because we do not want to shake the apple cart. But the fear here is that we are moving towards, what Friedman would have called the 'tyranny of the status quo', where we do nothing and nothing happens. The government has been asked to do its bit. But, can it do anything that can move us out?
The government now will have a task of balancing its budget as growth was estimated at 7.6% and will now be 6.5%. While higher inflation will make up partly, a shortfall is imminent. Add to this, the inaction on disinvestment and spectrum sale, and there are definite signs of fiscal slippage on the cards. A lot is being spoken on fuel subsidies, which is a small part of the overall picture. Real action is needed from the government, which is just not forthcoming.
Hence, the overall economic scenario needs affirmative action to be taken. The possible drought has literally cast a cloud and the absence of any ideas to move the economy ahead is a concern. While it is true that a similar story is narrated elsewhere, the fact that we are less affected by the global downturn should inspire us. However, with every organ of the state throwing up its arms, the picture is not exactly encouraging—in fact, it is discouraging.
The author is chief economist, CARE Ratings. Views are personal
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