The Reserve Bank of India (RBI), as was widely expected by economists, on Tuesday cut the repo rate and the cash reserve ratio (CRR) by 25 basis points each to 7.75% and 4%, respectively. The central bank also cut its gross domestic product (GDP) growth rate forecast for the current fiscal and year-end inflation estimate to 5.5% and 6.8%, respectively.
This policy stance, the central bank expects, will support growth by reviving investment and anchor medium-term inflation expectations. Though it kept its promise and delivered according to “expectations”, the question is will these changes make any difference in reviving investment and growth, especially when inflation continues to remain sticky. Governor D. Subbarao in his statement noted: “There is an increasing likelihood of inflation remaining range-bound around current levels going into 2013-14. This provides space, albeit limited, for monetary policy to give greater emphasis to growth risks.” It is, therefore, not surprising that both equity and bond markets barely moved after the announcement. In any case, given a reckless fiscal authority this prognosis is more in the nature of a prophecy than any realistic expectation.
However, even if one assumes that transmission of monetary policy is smooth and the rate cut will stimulate demand, the step is bound to put further pressure on the current account deficit (CAD). In the third quarter of the current fiscal, this is expected to be higher than the 5.4% of GDP recorded in the preceding quarter.
A higher level of sustained CAD has significantly increased the vulnerability on the external front and is now a clear and present danger to macroeconomic stability.
Clearly, as the 25 basis points cut in the policy rate is unlikely to do much for reviving growth, the central bank could have waited till the next quarter which would have allowed it to factor in the budget numbers and the intention of the government in pushing investment and clearing supply-side bottlenecks. It could have then made the policy action and guidance more credible. The downside would have been that it would have upset some overseas stock investors busy shipping dollars to the Indian market. That, given India’s economic travails, hardly counts for anything. To be sure, efforts to revive growth have to come from the government, as modest attempts like this one to cut the cost of capital will remain insufficient in reversing the country’s downward growth trajectory.
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